Informative Advertising: Additional Learning and Implications
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Observers argue that evidence for the persuasive role of advertising comes from competitive categories where increases in advertising lead to higher average prices. Conversely, others claim that advertising serves a purely informational role. Here, higher levels of advertising lead to better-informed consumers and this should increase competition and stimulate lower prices. The objective of this study is to neither confirm nor refute either of these perspectives of advertising. It is rather to show that increases in informative advertising alone can lead to both higher or lower prices. I further show that the direction of this relationship depends entirely on the level of differentiation between competing firms. This is done by extending the analysis of Grossman and Shapiro (1984) to conditions where the differences between competing products are more significant. The role of informative advertising is to inform consumers about individual products and higher advertising for a product means that more of the potential market knows about it. As the fraction of consumers informed about available products increases, the focal point of competition between firms changes. Changes in this focal point of competition is the basis for explaining why informative advertising can either push prices up or down in a uniformly distributed spatial market.Keywords:
Informative advertising
Grossman
Product Differentiation
Comparative advertising
False advertising
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Our objective is to broaden the current understanding of how horizontal differentiation interacts with both advertising and pricing by extending the analysis of Grossman and Shapiro (1984) to look at a full range of differentiation conditions. We seek to offer a useful perspective on the relationship between advertising and pricing by focusing attention on competitors whose essential difference prior to advertising and price decisions is product differentiation.
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Observers argue that evidence for the persuasive role of advertising comes from competitive categories where increases in advertising lead to higher average prices. Conversely, others claim that advertising serves a purely informational role. Here, higher levels of advertising lead to better-informed consumers and this should increase competition and stimulate lower prices. The objective of this study is to neither confirm nor refute either of these perspectives. It is rather to show that increases in informative advertising alone can lead to both higher or lower prices. I further show that the direction of this relationship depends on the level of differentiation between competing firms. Similar to Grossman and Shapiro (1984), I examine conditions where the differences between competing products are small, but I also examine conditions where the differences are significant. The role of advertising is to inform consumers about individual products and higher advertising for a product means that more of the potential market knows about it. Higher levels of advertising increase the relative importance of fully informed consumers compared to partially informed consumers. This dynamic is the basis for explaining why informative advertising can push prices either up or down in a uniformly distributed spatial market.
Informative advertising
Grossman
Comparative advertising
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One of the hallmarks of competitive interaction is each firm’s desire to differentiate from rivals. Although differentiation may be achieved through product related choices, advertising levels may constitute another key mechanism. In this paper, we examine under what conditions firms will elect to differentiate through product quality vs. advertising intensity and characterize the set of equilibria that emerge. Consumers can only purchase from the set of products they are informed about through advertising, and choose the alternative that maximizes their utility. Firms select product quality in a first stage, advertising levels in a second stage, and prices in the last stage. We study two forms of advertising–blanket and targeted. Under blanket advertising, firms communicate indiscriminately and a consumer’s probability of seeing an ad depends on the level of ad expenditure. We find that when advertising is ineffective, i.e., the additional awareness generated by a heavy level is modest relative to the cost, both firms choose a light ad spending. This allows them to minimally differentiate in qualities without concern of intense price competition, as each firm expects to have a segment of ‘captive’ consumers that are only aware of its product. When advertising is moderately effective, one firm shifts to expending heavily on advertising, hence all consumers are aware of its product. However, the rival prefers to differentiate by advertising lightly, while choosing the same maximal quality level. This strategy softens price competition by inducing the heavy-advertiser to price highly more often in order to capitalize on its captive segment and allows the light-advertiser to increase its average price. Interestingly, we show that even if advertising heavily entails no extra cost, one firm will choose to advertise lightly in equilibrium for strategic reasons. When advertising is very effective, both firms advertise heavily. In this scenario, firms must differentiate in qualities in order to achieve positive profits. Under targeted advertising, we let firms choose the segment(s) they wish to inform. We identify conditions such that both firms choose equally high quality products, but advertise to distinct segments; thereby achieving differentiation through ad targeting. We further show that this can result in a pocket of unserved consumers, even though consumers with lower willingness to pay purchase. Generally speaking, we show that allowing market awareness to be determined endogenously suggests far less product differentiation than previously suspected and reveals regions where advertising creates viable differentiation.
Duopoly
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Informative advertising
Empirical Research
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This thesis is concerned with the economic effects of advertising. Perhaps the most significant barrier to empirical work in the UK in this area is the lack of reliable, published data. Thus, at the heart of the thesis is a firm level questionnaire which provided advertising data on 325 large and medium-sized UK firms. Following a review of the theoretical and empirical literature in the area, the main empirical part of the of the thesis begins with an analysis of the determinants of both the advertising decision by firms and their advertising intensity. In particular, the standard modelling of the inverse U-curve relating advertising to market structure is re-specified using survey data. Following on from this, the effect of advertising on firm profitability is investigated. Evidence is found that profitability is higher for firms in consumer based industries who advertise heavily. In addition, firms who do not advertise seem more likely to go into receivership than others. Related to the question of profitability effects, previous work that persistent effects of advertising disappear when firm fixed effects are taken into account is called into question. On the question of persuasive and informative advertising, the evidence in the this study suggests that only a small proportion of firms include any information on prices in their advertisements. Consumer firms and those operating in a very competitive environment tend to be more likely to include at least some price information. The last section of the thesis looks at the strategic use of advertising. Evidence is presented that many firms do adjust their advertising in response both to rivals and to changes in business conditions. In many cases, these responses are found to be asymmetric: increasing in response to booms or rival increases but not decreasing in response to recessions or rival decreases.
Empirical evidence
Empirical Research
Informative advertising
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Grossman
Product Differentiation
Informative advertising
Symmetric equilibrium
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Despite the empirical relevance of advertising strategies in concentrated markets, the economics literature is largely silent on the effect of persuasive advertising strategies on pricing and market structure and increasing (or decreasing) dominance. We propose a simple model of persuasive advertising and pricing with differentiated goods and analyze the interdependencies between ex-ante asymmetries in consumer appeal, advertising and prices. We find that products with larger initial appeal to consumers will be advertised more heavily but priced at a higher level - that is, advertising and price discounts are strategic substitutes for products with asymmetric initial appeal. We find that the escalating effect of advertising dominates the moderating effect of pricing so that post-competition market shares are more asymmetric than pre-competition differences in consumer appeal. We further find that collusive advertising (but competitive pricing) generates the same market outcomes, and that network effects lead to even more extreme market outcomes, both directly and via the effect on advertising.
Dominance (genetics)
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This paper studies a duopoly industry where the firms compete for market shares by choosing output prices and advertising outlays. Advertising is purported here to be persuasive rather than informative as it is described in most signaling models. Persuasive advertising tends to cancel each other out and this leads us to question the possibility of firms reducing advertising outlays collusively. Using output cost to stand proxy for output quality, it is found that a robust positive association exists between output cost (quality), output price and advertising activity. We should therefore expect a firm producing higher output quality to advertise more and charge higher price than its lower quality rival even when neither advertising nor price is used as an information dissipating signal. Advertising is also found to be a credible tool to facilitate collusive commitment.
Duopoly
Proxy (statistics)
Informative advertising
Market share
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This paper examines how should firms allocate their advertising budgets between consumers who have a high preference for their products (strong segment) and those who prefer competing products (weak segment). Advertising transmits relevant information to otherwise uninformed consumers and can be used as a price discrimination device. We build on the model of Esteves and Resende (2016), analyzing how the ability to price discriminate through targeted advertising may affect firms' strategic behavior and equilibrium welfare outcomes. We find that price discrimination does not necessarily lead to the classical prisoner dilemma arising in several other contexts. The comparison of the optimal marketing-mix under mass advertising and targeted advertising strategies reveals that targeted advertising might constitute a tool to dampen price competition. We find that average prices with non-discrimination (and mass advertising) can be below those with price discrimination and targeted advertising (regardless of the market segment). We also find that, when advertising costs are not too high, firms are better off with price discrimination by means of targeted advertising than with mass advertising/no discrimination. Finally, we show that overall welfare and consumer surplus can fall down when firms use targeted advertising instead of mass advertising.
Price Discrimination
Targeted advertising
Economic surplus
Informative advertising
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The publication of Lester G. Telser's 1964 paper [52] was the starting point for much of the recent literature on advertising and competition. The major finding of that paper was that there is little empirical support for an inverse association between advertising and competition, despite some plausible theorizing to the contrary This review does not deal with the question of whether advertising is excessive, nor with the related issues of the welfare economics of advertising or product differentiation. Rather, it focuses on those papers which examine the impact of advertising on barriers to entry and on the extent of price competition. Advertising expenditures are designed to influence consumer demand for the firm's products. They may affect both direct and cross-elasticities of demand. Those who argue that advertising may limit competition maintain that the relevant demand curves[1] are more inelastic and that cross-elasticities are lower as a result, while those who dispute this contention suggest that advertising has no such influence or even that it leads to more elastic demands and higher cross-elasticities. Much controversy has therefore turned on the direction of the effects of advertising on demand elasticities. [Авторский текст]
Product Differentiation
Consumer welfare
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Citations (268)