Signaling

Signaling is a mechanism by which an informed party takes a costly action to credibly communicate their private quality to an uninformed party. For the signal to be effective — producing a separating equilibrium — the signal must be cheaper for high-quality agents to send than for low-quality agents:

This single-crossing condition is what makes the signal credible: low types cannot profitably mimic high types, so the uninformed side can read the signal and update accordingly. The lectures develop two canonical examples: warranty length as a signal of car quality (offering a warranty is cheap for good-car sellers who rarely need to honour it, expensive for bad-car sellers who would), and Spence's (1973) model of education as a signal — degrees separate high- and low-productivity workers even if education adds no productive value, at the potential social cost of resources spent on a signaling activity with no direct return. See Topic 1 — Asymmetric Information.

When to use

Use the signaling framework whenever the informed side can take a costly observable action to reveal their type. The key diagnostic is the single-crossing condition: check whether the signal is relatively cheaper for the high type. If it is, a separating equilibrium can exist; if both types face the same signaling cost, separation fails and only a pooling equilibrium is possible.