Economics Letters 69 (2000) 359–363 www.elsevier.com / locate / econbase Costly signal extraction and profit differentials in oligopolistic markets a b, * Mustafa Caglayan , Murat Usman a University of Durham, Department of Economics and Finance, 23 –26 Old Elvet, Durham DH33HY, UK b Koc University, College of Administrative Sciences and Economics, Cayir Caddesi, Istinye, 80860 Istanbul, Turkey Received 6 June 2000; accepted 16 June 2000 Abstract Empirical evidence indicates that there can be persistent profit differentials between firms in an industry. We show that demand uncertainty and costly information acquisition by firms on market demand leads to significant profit differentials for intermediate levels of demand variability.  2000 Elsevier Science S.A. All rights reserved. Keywords: Signal extraction; Demand uncertainty; Duopoly. JEL classification: D83; L13 1. Introduction Empirical evidence indicates that firms in the same industry often differ in their performances. 1 Furthermore, the difference in firm profits persists over relatively long time periods. This paper offers a simple explanation for this puzzling phenomenon: When information acquisition is costly, demand 2 uncertainty can cause profits to diverge even if all firms are ex ante identical. Even though firms are similar in terms of technology or product space, firm profits will differ. Poorly informed firms will employ a suboptimal number of workers or invest suboptimally and therefore, will enjoy lower profits than their better informed rivals. We consider a symmetric, two-firm Cournot model with demand uncertainty. Each firm, before choosing its output level, decides whether to acquire information at some cost. The information that *Corresponding author. Tel.: 190-212-229-3006; fax: 190-212-229-6674. E-mail address: musman@ku.edu.tr (M. Usman). 1 See Mueller (1986, 1990). 2 ¨ ´ For some alternative explanations, see Barney (1986) and Roller and Sinclair-Desgagne (1996). 0165-1765 / 00 / $ – see front matter  2000 Elsevier Science S.A. All rights reserved. PII: S0165-1765(00)00333-5