What is the signaling function of price mechanism in microeconomics?
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The signaling function of the price mechanism in microeconomics is to communicate information about the quality of a product to consumers. When there is information asymmetry in the market, firms use the price signal to convey the unobservable quality of their products to consumers. This allows consumers to make informed decisions about which products to purchase. The price signal can be used to indicate high quality by setting a price either below or above a certain range called the "quality suspicion range" . Price signaling can also affect the pass-through of cost shocks to price, leading to changes in price and quality by the firm . In a market with directed search and signaling, sellers' choices of prices and sites can direct buyers' search decisions and signal quality ex-ante . However, signaling through prices may exacerbate adverse selection and lead to absence of trade, even when trade would be mutually beneficial .
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