Why Market Shares Matter: An Information-Based Theory

Consider a duopoly market in which consumers have heterogeneous information about the quality differential q of the two goods. When firms are ignorant about q, consumers rationally believe that a firm with high market shares is likely to produce a high-quality good. As a result, firms try to signal-jam the inferences of consumers and compete for market shares beyond the level explained by short-run profit maximization. When firms know q, multiple equilibria may exist, but there is always one equilibrium in which market shares signal quality, and then the market tends to be more competitive.