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  Signaling

Signaling:

The problem of low-quality choice may be overcome if one firm is able to build up a reputation for high quality. The temptation of breaking the promise of always producing and delivering high-quality goods is tempered by the loss in reputation and the consequent drop in price on future goods, even if they are of high-quality. Consumers who understand that firms with a reputation for high quality will suffer greatly if they break their promise, will believe it and are prepared to pay a high price. In a sense they judge quality by price; higher price signals a high quality. Another device is a warranty, the readiness to give a generous warranty (or a money-back guarantee), signals that the seller is confident that the widget has a high quality.

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