The Korean Economic Review
Return Policy as a Signaling Device in Horizontally Differentiated Products
Sawoong KangYear 2006Vol. 22No. 2
We consider a market for horizontally differentiated product in which theinformation about the location of the product is asymmetric between amonopolist and buyers. The vertical characteristic of the product (i.e.,quality) is assumed to be common knowledge. Product differentiation ismodeled a la Hotelling. Three types of sellers are assumed: A and C at twoendpoints and B at the center. We analyze two signaling games, one withprice being a signaling device and another with return policy. We show thatreturn policy is a more efficient signaling device than price. When returnpolicy can be adopted, (a) for most parameter values, there exists aseparating equilibrium in which only seller B uses the return policy; (b) Apooling equilibrium in which all sellers use the return policy also exists; (c)Whenever return policy is adopted by some seller, it improves social welfare.