Word‐of‐Mouth Communication and Price as a Signal of Quality

This paper demonstrates that word‐of‐mouth communication between consumers provides a mechanism to support signalling. Particularly, a separating equilibrium can be supported where a low introductory price signals high quality. The equilibrium price path is qualitatively similar to that supported by repeat buying. Separation is less likely than in repeat buying because word‐of‐mouth communication between consumers is likely to be less effective in transmitting information than repeat buying. The equivalence of word‐of‐mouth communication and repeat buying breaks down entirely when communication is costly because consumers then have a strict incentive not to communicate if separation occurs. This undermines the mechanism that supports the separation.