Course

Signaling

Instructor: Tyler Cowen, George Mason University

Signaling : Expensive actions taken by one party to credibly convey information to others. This is from the video “ Signaling ” in the Principles of Microeconomics

Signaling: Expensive actions taken by one party to credibly convey information to others. This is from the video “Signaling” in the Principles of Microeconomics course.

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Transcript

So again, we have a case of asymmetric information where Hyundai knew much more about the quality of its products than did consumers. So, what could the company do? Hyundai rolled out what it called “America's Best Warranty.” The warranty assured consumers that the cars were high quality and it got consumers to start buying those cars. What's great about this idea is that it doesn't actually cost Hyundai very much because the cars were in fact high quality and they didn't need to be fixed all the time. This Hyundai warranty is an example of a signal.


A signal is an expensive action that reveals information, and for it to work a signal has to be credible. In this case, if Hyundai cars were still unreliable, such a comprehensive warranty would have been extremely costly to Hyundai. Consumers, Therefore, bought Hyundai figuring that if the warranty were so strong, well, the company had to have a lot of faith in its cars.


So how does a signal help alleviate asymmetric information? Hyundai knew their cars were of high quality but consumers didn't know. The warranty was a credible signal that conveyed information to the consumers, specifically information about the quality under the hood, that consumers otherwise couldn't easily judge. This signal gave consumer the information necessary to have enough confidence to buy a Hyundai.

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