False Advertising, Market Competition, and Consumer Protection

We examine a model in which firms produce goods that are both vertically and horizontally differentiated. While firms know the quality of their product, either high or low, it is unobservable to consumers. Firms signal quality to consumers, and we investigate how market rivalry and public enforcement influence their incentives to misrepresent quality, as well as the implications for consumer welfare. Our analysis reveals that stronger enforcement, by curbing false advertising, can drive a low-quality signaling firm out of the market. This strengthens the market power of a high-quality signaling firm, leading to higher prices and ultimately harming consumers.