WORD-OF-MOUTH COMMUNICATION AND PRICE AS A SIGNAL OF QUALITY

This paper demonstrates that word-of-mouth communication between consu mers provides a mechanism to support signalling. Particularly, a separ ating equilibrium can be supported where a low introductory price sign als 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 b uying. The equivalence of word-of-mouth communication and repeat buyin g 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.