Signaling with Imperfect Competition*

We analyze a duopoly model where …rms sell conspicuous goods to horizontallyand vertically-di¤erentiated consumers. These consumers care about both the intrinsic quality of the goods they purchase as well as the “social status”conveyed by these goods (namely, the social inference of their hidden wealth based on their purchase). Firms o¤er non-linear price and quality schedules that, in e¤ect, screen consumers using a combination of two instruments: supra-normal markups (or “Veblen e¤ects”) and upward-distortions in quality. Our work differs from previous literature in that Veblen e¤ects and quality distortions simultaneously arise, and it also provides a setting in which their interaction can be analyzed. The two screening instruments have very di¤erent welfare implications, with markups being welfare enhancing since, through them, …rms create an implicit market for social status that reduces the need for quality distortions as a means to settle the status race. The model also accounts for the commonly observed practice among luxury brands of selling goods with essentially the same intrinsic features at considerably di¤erent prices. Finally, we show that once the forces of imperfect competition are considered, optimal corrective taxation di¤ers signi…cantly from standard proposals.