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I investigate a pricing strategy that is aimed at deterring entry by applying a two-period model of a durable-goods monopolist. There exists an incumbent that is of two types, that is, high and low quality types. They differ in terms of their R&D capabilities, and the incumbent's type is assumed to be unknown to an entrant. If the entrant decided to enter the market, Nash–Bertrand price competition ensues between the incumbent and the entrant. I show that not only limit pricing but also prestige pricing signals the incumbent's quality type, which serves to discourage entry. In the prestige pricing, the high-quality type sells the products at an intentionally higher price. I also show that although limit pricing is more desirable than prestige pricing from a social welfare viewpoint, the incumbent can still choose prestige pricing.

I investigate a pricing strategy that is aimed at deterring entry when there is asymmetric information. The focus is on the signaling role of prestige pricing, where the incumbent sells its products at an intentionally high price. In reality, firms that deal in high-quality goods, such as exclusive bags, watches, and electrical appliances, use prestige pricing. The common belief is that consumers tend to see a high price as an indication of high quality. Therefore, by charging an intentionally high price, these firms seek to emphasize the high-quality and high class of their products. In this paper, I use a durable-goods model in order to examine the role of prestige pricing in discouraging entry. The results suggest that prestige pricing actually affects rival (potential) firms rather than consumers. The high price shows not only the high-quality of present products but also that of future products. In particular, this pricing indicates a company's strong confidence in the future innovation and future development of its products and thus discourages potential entrants. Many papers have investigated the relationship between pricing strategy and entry.1Milgrom and Roberts (1982a) allowed for the existence of asymmetric information when considering the cost structure of the incumbent and showed that a low-cost type incumbent can use limit pricing as a signal of its cost structure. Harrington (1987) and Bagwell and Ramey (1991) analyzed an oligopoly case where many incumbent firms and a potential entrant exist.2LeBranc (1992) investigated the role of limit pricing and predatory pricing in deterring entry.3 All of these papers assumed the existence of asymmetric information about the cost structure of the incumbent.4Linnemer (1998) considered a case where the cost structure and product quality are unknown, and showed that price and advertising play the signaling role in the entry deterrence problem.5 On the other hand, this paper analyzes the effect of pricing strategy on entry behavior when the product's quality is uncertain. I analyze the case where the R&D capability of an incumbent is uncertain, namely, the level of quality of the new products is private information. I demonstrate that pricing can signal the incumbent's quality type and thereby serves to deter entry. It is shown that not only limit pricing but also prestige pricing plays a signaling role in deterring entry. Economic analyses of a durable-goods monopolist originated from Coase (1972).6 He conjectured that durable goods monopolist faces time inconsistency. (See Stokey (1981) for the discussion on the Coase's conjecture.) Bulow (1982) constructed a two-period model of durable goods monopolist and theoretically proved that time inconsistency problem occurs.7Waldman (1993) and Choi (1994) investigated the decision by a durable-goods monopolist on new product introduction.8Waldman, 1996a and Waldman, 1996b and Hendel and Lizzeri (1999a) strictly investigated the interaction between the old and new products by considering a secondhand market. Especially, Waldman (1996a) proved that the time inconsistency problem concerning R&D decision rather improves social welfare.9 Using durable-goods monopolist models, Hendel and Lizzeri (2002) and Johnson and Waldman (2003) considered situations where asymmetric information exists about the level of product quality and analyzed the role that leasing plays on the adverse selection problem.10Utaka (2006b) also assumed the existence of asymmetric information about product quality and investigated the role of durable-goods warranties in the moral hazard problem. This paper investigates the signaling effect of pricing strategy in deterring entry.11 I use a two-period model of a durable-goods monopolist in which there is an incumbent that is of two types, that is, high and low quality types. They differ in terms of their R&D capabilities that determine the quality levels of new products released in the second period. The incumbent's type is unknown to the entrant in the first period. The entrant has to decide whether to enter the market during the first period without knowing the incumbent's R&D capabilities. Accordingly, it guesses the incumbent's type on the basis of the price of the first-period products. If the entrant decided to enter the market, Nash–Bertrand price competition ensues between the incumbent and the entrant. In the second period, the first-period products are traded in a secondhand market. Under these settings, I explore the incumbent's pricing strategy that is aimed at discouraging entry. It is shown that in cases where the probability of the incumbent being of a high-quality type is not so high, two kinds of signaling equilibria occur: limit pricing and prestige pricing equilibria. In the prestige pricing strategy, the high-quality type sells products to fewer customers at a higher price in the first period. I show that these pricing strategies can signal that the products are of high quality, and that this deters entry. Although these strategies reduce the first-period profits of the incumbent, deterring entry brings the high-quality incumbent larger second-period profits. With prestige pricing, the important point to mention is that the lower sales of the first-period products reduce the substitutability between new and old products. In the durable-goods model, the existence of secondhand goods decreases the prices of new products.12 In this paper, I show that prestige pricing also raises the price of new products, because the high-quality incumbent sells them only to consumers who do not have older products. Instead of using this pricing strategy, on the other hand, the lower type prefers to maximize its first-period profits, even if this behavior reveals its quality type. From a social welfare viewpoint, limit pricing is more desirable than prestige pricing. Nevertheless, in cases where the quality level of first-period products is sufficiently high, the incumbent can still choose prestige pricing. The main reason for this is that prestige pricing enables the incumbent to sell its new products at a higher price in the second period because of the fall in first-period product sales. As the quality of first-period products increases, a larger difference can be seen between the price of new products in prestige pricing and that in limit pricing. Therefore, it is more profitable for a high-quality incumbent to use prestige pricing than limit pricing. The following organization of this paper is as follows. First, I will introduce the basic structure of the model. Then, I will present my investigation of the signaling roles of limit pricing and prestige pricing in deterring market entry. Finally, the analysis of a firm's decision between limit pricing and prestige pricing is presented.

I considered a two-period model of a durable-goods monopolist, and explored the firm's decision on pricing strategy that aims to deter entry. As a result, it has been shown that not only limit pricing but also prestige pricing signals the high quality of the product to the entrant, which serves to deter entry. Although limit pricing is more desirable than prestige pricing from a viewpoint of social welfare, the incumbent firm can still choose prestige pricing, in cases where the quality level of first-period products is high. The important point is that in the durable-goods model, the existence of secondhand goods has an effect on the price of new products. Since I used a durable-goods model with three types of consumers for this research, the range of pricing choices was somewhat narrow. If we succeed in constructing a generalized model where n types or a continuum of consumer types exists, we may be able to make a more detailed analysis of the signaling role of a pricing strategy.