Consumer information and the limits to competition

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