Signaling Through Pricing by Service Providers with Social Preferences

TLDR: A game-theoretic model is developed to investigate pricing strategies and the market outcome in service markets where the provider has two-dimensional private information about her own type whether ethical or self-interested and about the customer's condition whether serious or minor.

Abstract: In many service markets such as consulting, auto repair, financial planning, and healthcare, the service provider may have more information about the customer's problem than the customer, and different customers may impose different costs on the service provider. In principle, the service provider should ethically care about the customer's welfare, but it is possible that a provider may maximize only its own profit. Moreover, the customer may not know ex ante whether the provider is ethical or purely self-interested. We develop a game-theoretic model to investigate pricing strategies and the market outcome in service markets where the provider has two-dimensional private information about her own type whether ethical or self-interested and about the customer's condition whether serious or minor. We show that in a less ethical market, a self-interested provider will charge different prices based on the customer's condition, whereas an ethical provider will charge the same price for both conditions. In contrast, in a more ethical market, both the self-interested and the ethical provider will charge the same uniform price to both types of customers. Interestingly, both market efficiency and the customer's ex ante expected surplus might be lower in a more ethical market than in a less ethical one.