Signaling Through Pricing by Service Providers with Social Preferences

Abstract

In many services 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 services 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.

Keywords: social preference, signaling, credence goods, pricing, behavioral economics, asymmetric information