Information structures and their effects on consumption decisions and prices

Moreno González, Othón M.
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This work analyzes the effects that different information structures on the demand side of the market have on consumption decisions and the way prices are determined. We develop three theoretical models to address this issue in a systematic way. First, we focus our attention on the consumers' awareness, or lack thereof, of substitute products in the market and the strategic interaction between firms competing in prices and costly advertising in such an environment. We find that prior information held by consumers can drastically change the advertising equilibrium predictions. In particular, we provide sufficient conditions for the existence of three types of equilibria, in addition to one previously found in the literature, and provide a necessary condition for a fourth type of equilibrium. Additionally, we show that the effect of the resulting advertising strategies on the expected transaction price is qualitatively significant, although ambiguous when compared to the case of a newly formed market. We can establish, however, that the transaction price is increasing in the size of the smaller firm's captive market. In the second chapter, we study the optimal timing to buy a durable good with an embedded option to resell it at some point in the future, as well as its reservation price, where the agent faces Knightian uncertainty about the process generating the market prices. The problem is modeled as a stopping problem with multiple priors in continuous time with infinite horizon. We find that the direction of the change in the buyer's reservation price depends on the particular parametrization of the model. Furthermore, the change in the buying threshold due to an increase in ambiguity is greater as the fraction of the market at which the agent can resell the good decreases, and the value of the embedded option is decreasing in the perceived level of ambiguity. Finally, we introduce Knightian uncertainty to a model of price search by letting the consumers be ambiguous regarding the industry's cost of production. We characterize the equilibria of this game for high and low levels of the search cost and show that firms extract abnormal profits for low realizations of the marginal cost. Furthermore, we show that, as the search cost goes to zero, the equilibrium of the game under the low cost regime does not converge to the Bertrand marginal-cost pricing. Instead firms follow a mixed-strategy that includes all prices between the high and low production costs.