Quality Signals, Competition and Consumer Fraud∗

This paper considers a two-sided private information model. We discuss the signaling role of consumers ’ private but imperfect information together with the effect of competition on the equilibrium level of honesty and incidence of fraud. We assume that two exogenously given qualities, which are represented by sellers types, are offered in the market. Prices are fixed. Low quality sellers choose to be either honest (by charging the lower market price) or dishonest (by charging the higher price). We demonstrate that in equilibrium, the amount of fraud might increase when the precision of the buyer’s private information increases. Furthermore, we show that the level of dishonesty is non-decreasing in the level of market competition in equilibrium