When a prospective home buyer discovers a house that appears to him to be flawless but that has been on the market for some time, he is naturally suspicious about the reason it did not sell earlier. (The analysis proposed here can be applied to the sale of a variety of items such as a durable piece of equipment, a business, or a work-of-art. The discussion is set in the context of a housing market merely for concreteness.) There are three possible explanations (two good and one bad). First, he may be the first potential buyer to have discovered the house. Second, the house simply may have been over-priced given the tastes of earlier potential buyers. Third (and most worrisome), earlier potential buyers may have detected a flaw in the house not apparent to him. The weight he ascribes to each of these possibilities depends upon the characteristics of the market such as the overall level of demand, the distribution of buyer tastes, and whether he can observe the history of previously posted prices. Also, the seller of the house may be able to influence a potential buyer's quality assessment through her pricing strategy and disclosure of information. This project studies these issues of imperfect information transmission in a model of two-sided asymmetric information and consumer learning with the following structure. The seller is presumed to know the quality of her house, but posts asking-prices over time without knowing the realization of consumer tastes. Consumers know their own idiosyncratic preferences when making offers, but do not know the quality of the house. The consumer who makes the highest offer commits to buy the house subject to a favorable inspection on quality. In addition, consumers who discover the house on the market late in the selling season use time-on-the-market to update their assessments of quality. Preliminary findings suggest several intriguing phenomena. First, when inspection outcomes are not publicly recorded and consumers observe the history of asking prices, the seller has an incentive to post inordinately high prices early in the selling season in order to ``dampen'' the signal transmitted to prospective buyers who may discover the house for sale late in the season. If a potential buyer who arrives late in the season knows that the seller's initial asking price was relatively high, then he is apt to believe that the house did not sell earlier due to lack of a suitable buyer (i.e., one who liked it enough to pay the high asking price). Conversely, if a potential buyer who arrives late in the season knows that the seller's initial asking price was relatively low, then he is apt to believe that the house did not sell earlier due to detection of low quality. Another way of saying this is that a prospective buyer who walks away from a high-priced house conveys little information concerning quality to subsequent buyers, but a prospective buyer who walks away from a low-priced house transmits a very strong signal regarding his assessment of quality. In the case when inspection outcomes are not publicly recorded and consumers do not observe the history of asking prices, the seller has an incentive to post inordinately low prices early in the selling season in order to make an early sale and thereby avoid the transmission of unfavorable information. The essence of this finding is captured in the often-heard folk wisdom that a seller should beware of setting her initial price too high. The danger from over-pricing in early periods is that a buyer who arrives late and who does not observe the price history will naturally be suspicious about the reason the house did not sell earlier. The cost of correcting the initial over-pricing at this juncture is high as compared with the cost of posting a lower initial price to begin with. Indeed, a seller who posts too high an initial price may be tempted to continue over-pricing in later periods resulting in a vicious circle of rejected offers and falling prices. Ultimately, the seller may be forced to remove her house from the market or to make a sale at a very low price as compared with what she could have secured in early periods. Preliminary findings also suggest theoretical support for laws that require inspection outcomes to be publicly filed and for the use of reputable brokers. Such measures can ease potential buyers' concerns about quality and the concomitant inefficiency. Several extensions to the basic model are also proposed for study. First, it is natural to investigate the impact of inspection costs. It is conjectured that higher inspection costs will generate more inefficiency but that problems involving the transmission of information will be ameliorated to some degree. Second, environments in which the seller of a high-quality home can signal the value of her house by posting a high asking-price are proposed for study. An intriguing possibility here is that the price of a house might actually rise between periods as the seller of a high-quality house switches from a `pooling` to a `separating` phase of the equilibrium. Such anomalous pricing behavior is sometimes observed in real estate and other markets. A final extension of the basic model proposed for study is to consider environments in which the seller has less commitment and bargaining power.
