So, now I want to talk to you about signaling games. Now, signaling games are a particular type of sequential game. What is a sequential game mean? It means that one of the players gets to move first. And the other player observes what they do before they make their own decision. So signaling really involves the selective communication of information to potential rivals to influence their belief and change behavior and it does so through a series of commitments. Here is the way you want to think about this. In a signaling game, I go before the world and I say, here I am, I have done this thing that is very difficult. And if I weren't who I say I am, I would have not been able to do this difficult thing. It would have just been way too hard, so because you see me do it, you should believe exactly what I say about me. For example, people like to signal to the world that they're smart, what's one way to do that? You can get an MBA, that is a signaling mechanism, why? Because in order to get an MBA from the Darton school, you have to come to the Darton school for almost two years. You have to work very hard, you have to spend a certain amount of money. And what the individuals that come to Darton say is, look, I have gone through this difficult process. I have learned all of this material. I've passed my classes. I've paid my money. And I'm making a bet on myself that I can go out into the world and do great things. And you should believe me because I went and got my MBA. And if I wasn't that bright, if I wasn't that capable, there's no way I would have been able to go do this. So people like to signal that they're smart. Some people also like to signal that they're wealthy. They may go buy very expensive jewelry. This looks like a very expensive piece of jewelry. And what they're telling the world is, if I was poor, there is no way I could get enough money to buy this beautiful diamond ring sitting right here. So the fact that I'm wearing this beautiful diamond ring means to you, I'm wealthy. This is a credible view, a credible commitment to the signal to you that I'm wealthy. So, signaling is very common in nature. I just gave you a couple of human examples, but some of you may know this. Animals signal all the time. Look at this peacock. What is this peacock saying? It's got the beautiful tail feathers. It's saying, here I am, I'm big, I'm beautiful, I'm strong, I'd make a great mate. That's what that peacock is saying. This kind of competition in mating behavior happens in the animal kingdom all the time and generally it happens through signaling, not fighting between animals but animals doing things that are difficult for weaker less beautiful animals to do. And in so doing that, they send a credible signal to their mate that, yes, I am indeed good mate material. Now, signaling happens in the pricing world as well, and that's really what we're interested in. So let's think about this basic signaling game. One, we have an incumbent and an entrant. An incumbent means you've been in the market for a while, you kind of know what's going on in the market. And then an entrant means you're new, right, you haven't been doing business in this space. An incumbent business sets a price before another business enters the market. That's realistic. An entering firm is going to be able to see an incumbent firm's price that they have out there. The incumbent knows when they set the price whether the market conditions are good or bad, you can think about this as being, the incumbent knows what the demand conditions are, right? We've talked about demand conditions in the course, sometimes it's hard for an entrant to know what those demand conditions are, but an incumbent is going to have a much better idea. The entrant just is more ignorant. However, what the entrant does see is it sees the price set by the incumbent. The incumbent chooses a price and then the entrant decides, based on that price which might have some information in it, whether they're really going to decide to enter the market or not. And in the next module coming up, I'm going to show a very formal example of just this type of game.
