Price signals quality: The case of perfectly inelastic demand

This paper considers the pricing decision by a seller who has private information about quality. Demand is perfectly inelastic (rectangular). For example, there may be a single buyer who wants exactly one unit and whose valuation is known by the seller. It;is noted that, contrary to widespread belief, separating equilibria do exist in this model, allowing some trade of high quality products even when the average quality is low. Moreover, by. slightly perturbing demand, we can use standard equilibrium refinements to uniquely select the best separating equilibrium outcome. Since the chosen outcome has a very simple structure regardless of the number of quality levels, this model could be a useful workhorse in applications. (C) 1997 Elsevier Science B.V.