Information Generation in Vertically Differentiated Markets*

Abstract

In a model of vertical competition two firms draw costly public signals that are informative about the quality of their products and then competitively set prices. When each firm generates information independently from the other, there will be overinvestment (underinvestment) in information generation if the market share of the quality follower in the subsequent market equilibrium is high (low). Moreover, information generation by one firm has a positive externality on the other firm. Hence, coordination (e.g., via industry associations) increases information generation. When product qualities are endogenous, information generation may prevent quality degradation and thus have an additional social benefit.