An economic mechanism by which an informed party conveys credible information about its unobservable attributes or intentions to uninformed parties through observable actions whose costs or payoffs differ by type, so that observers update beliefs and change behaviour accordingly.

Principle

An observable action becomes a credible signal when its cost or payoff structure makes it relatively less costly (or more profitable) for one type than for others, producing incentive-compatible separation of types.

Demonstration

Situation: Employers cannot directly observe worker ability. Recognition: Employers treat educational credentials as potentially informative. Action: High-ability applicants obtain credentials despite cost; low-ability applicants find the net cost prohibitive. Consequence: Credentials alter employers' beliefs and hiring offers, partially separating high- and low-ability applicants.

Misapplication

Treating any observable action as a signal without checking differential cost or payoff; e.g., interpreting low-cost advertising as credible evidence of quality when it imposes equal cost on low- and high-quality providers.

Consequence

Alters market beliefs and allocations: when signals work, they can generate separating equilibria, change prices or wages, and reduce information frictions; when they fail, markets may pool on prior beliefs.

Reversal

If observers cannot observe the cost/payoff or if the action is costless and unverifiable (pure cheap talk), or if independent verification/certification exists, the signalling mechanism loses credibility and does not change beliefs.

Boundary

Clearly within: costly, observable actions whose costs vary with private attributes. Boundary case: warranties or certifications that mix signaling and third-party verification. Clearly outside: pure cheap talk or mere publicity without differential cost.

Semantic Tension

Signaling ↔ Screening — signaling is initiated by the informed party to reveal private traits; screening is initiated by the uninformed party to elicit information.

Synthesis

Signaling converts private information into public inference by making truthful behaviour the incentive-compatible choice for some types; its effectiveness depends on differential cost structures and the availability of independent verification.