Suppose customers believe that the good they are buying is of high quality with a probability of p, and of low quality with probability 1 - p. A high quality good is valued at vH and costs cH to produce, while a low quality good is valued at vL and costs cL to produce.
a) If high quality firms do nothing to signal their quality, what price would (risk neutral) consumers be willing to pay for the product?
b) Let cH = 9/10vH and vH = 2vL
For what values of p could consumer beliefs about quality be consistent? (That is, for what values of p is there actually a positive probability that some firms are producing high-quality goods?)