Consumer Information and the Limits to Competition

Abstract

This paper studies competition between firms when consumers observe a private signal of their preferences over products. Within the class of signal structures that induce pure-strategy pricing equilibria, we derive signal structures that are optimal for firms and those that are optimal for consumers. The firm-optimal policy amplifies underlying product differentiation, thereby relaxing competition, while ensuring consumers purchase their preferred product, thereby maximizing total welfare. The consumer-optimal policy dampens differentiation, which intensifies competition, but induces some consumers to buy their less preferred product. Our analysis sheds light on the limits to competition when the information possessed by consumers can be designed flexibly. (JEL D11, D21, D43, D82, D83, L13)