Convincing Early Adopters: Price Signals and Information Transmission

We study the pricing strategy for a new product when consumerslearn from both prices and early adopters' purchase decisions. A monopolist faces a representative consumereach period and is privately informed about... [ view full abstract ]

We study the pricing strategy for a new product when consumers
learn from both prices and early adopters' purchase decisions. A monopolist faces a representative consumer
each period and is privately informed about his  probability of producing good-quality products. Early adopters learn quality before purchasing the product.
Second-period consumers learn about product quality only Through observation
of past prices and early adopters' purchase
decisions. Prices play a dual role,  signalling 
the firm's type and facilitating or impeding information transmission
from early adopters. Our main result
is that separation might occur through either high or low prices. When demand for good-quality products is less
elastic, high prices are less costly for high-type firms due to
 static (through demand) and dynamic (through information transmission)
effects. High-type firms are marginally less affected
by high prices, since they lose fewer consumers. Moreover,
early sales at higher prices carry good news about quality , since they are more likely to come from a good quality product. The opposite happens occurs when good-quality products are more elastic. We provide examples
showing that in the case of disruptive (incremental)
innovations high (low) prices can be used as signals of quality. We
finally discuss consumer welfare.