Consider as above a market in which firms have private information about their quality s ∈ [0, 1]. Quality is drawn from the uniform distribution on the 0-1 interval; this is common knowledge among firm and consumers. After observing its type the firm decides whether to reveal its quality to consumers (it has the choice whether or not to reveal its quality but not to mislead; a justification is that the firms sends a sample to a certifying authority for testing but that publishing the test result is within its own control) and sets a price p. Consumers derive utility u = s^e - p, where se denotes the expected quality. With probability λ (which is independent of quality) the firm can costlessly disclose information, with the remaining probability it cannot disclose information on product quality.

1. Characterize the solution to the firm’s pricing and information disclosure problem.

2. Discuss your result in light of the results obtained in the previous exercise.

3. Does mandatory disclosure increase welfare? Discuss.