Solution Manual for Modern Industrial Organization (Global Edition) by Carlton & Perloff – Complete Answers & Exercises

Chapter 14 V

AdvertisingVandVDisclosure

TheVmaterialVonVadvertisingVisVimportant:VyouVcanVremindVstudentsVthatVsomeVveryVlargeVcompanie
sVspendVmoreVthanVoneVfifthVofVtheirVannualVsaleVreceiptsVinVadvertisementVofVvariousVkinds.VMost
VofVtheVstudentsVhaveValreadyVnotedVthatVstandardVmodelsVofVcompetitionVdoVnotVtakeVintoVaccount
VthisVimportantVactivity.VIfVyouVareVnotVgoingVtoVcoverVtheVentireVchapter,VyouVmayVwantVtoVuseVt
heVbasicVmaterialVonVadvertisingVwhenVdiscussingVproductVdifferentiationV(ChapterV7)VandVstrategicV
behaviorV(ChapterV11).

AtVaVminimum,VweVrecommendVpresentingVthisVbasicVmaterialVonVadvertising.VItVincludesVaVdiscuss
ionVofVtheVtwoVtypesVofVadvertising,VandVofVtheVoptimalityVrule:VaVfirmVshouldVadvertiseVtoVtheVpo
intVwhereVitsVmarginalVbenefitVequalsVitsVmarginalVcost.VThisVresultVisVderivedVgraphicallyVandVinVa
VtechnicalVappendix,VwhichVisVnotVveryVdifficultVandVcouldVbeVusedVwithVundergraduatesVwhoVhave
VsomeVknowledgeVofVcalculus.VTheVappendixVdiffersVfromVtheVusualVpresentationVinVitsVchoiceVofV
outputVratherVthanVpriceVasVtheVotherVcontrolVvariableVbesidesVadvertising.VByVmakingVthisVswitch,V
theVoptimizationVconditionsVresembleVtheVusualVconditionsVthatVareVcoveredVinVtheVearlierVchaptersV
onVmarketVstructure.VItValsoVmakesVtheVpresentationVslightlyVeasier.
StudentsVmayVremarkVonVtheVdifficultyVofVassessingVtheVbenefitsVofVadvertising,VsoVyouVcanVuseVth
isVasVaVlinkVtoVdiscussVempiricalVevidence.

ItVisVparticularlyVimportantVtoVstressVtwoVdistinctionsVmadeVinVtheVtext.VTheVfirstVoneVisVbetween
VtheVsearchVandVexperienceVqualitiesVofVvariousVgoods.VTheVsecond,VcloselyVrelated,VdefinesVtwoV
kindsVofVadvertising:VinformativeVandVpersuasive.VItVshouldVnotVbeVsurprisingVthatVwelfareVresultsV
withVregardsVtoVinformativeVadvertisingVareVstraightforwardVandVrelateVdirectlyVtoVresultsVofVtheVp
recedingVchapterVonVinformation.VTheVimpactVandVdesirabilityVofVpersuasiveVadvertisingVareVmuch
VharderVtoVassess.VIfVsomeVeconomistsVconcedeVthatVsuchVmessagesVmayVhelpVcreateVspuriousVpro
ductVdifferentiationVandVbarriersVtoVentry,VtheyVareVgenerallyVloathVtoVenterVintoVargumentsVthatVu
ndermineVtheVideaVofVconsumerVsovereignty.

TheVmaterialVonVtheVDixit-
NormanVresultVisVparticularlyVcontroversial.VFollowingVthisVdebateVisVlikeVtryingV toVplayVcatchVwit
hVJello.VNonetheless,VstudentsVnormallyVenjoyVit.VStudentsValmostValwaysVhaveVstronglyVheldVopini
onsVonVthisVtopic.VWeVusuallyVaskVtwoVstudentsVtoVdebateVtheVmaterialVwithVcontributionsVfromVth
eVrestVofVtheVclass.

OneVcanVskipVtheVmaterialVonVdisclosure.VThisVmaterial,Vhowever,VisVpopularVwithVstudentsVbecause
VtheVbasicVresultVisVinitiallyVcounter-
intuitiveVtoVmostVofVthem.VItVisVaVgoodVideaVtoVstressVthatVtheVstrongestVresultsVhereVdependVonVst
rongVassumptionsVthatVprobablyVdoVnotVholdVinVmostVmarkets.VTheVdisclosureVmaterialVmakesVaVni
ceVcomplementVtoVtheVdiscussionVofVfalseVorVmisleadingVadvertising.

, ChapterV14V V AdvertisingVandVDisclosure 53



■ AdditionalVExample
SearchVEngineVResultsVAdvertising?

InV2003,VLouisVVuittonVSAVfiledVsuitVagainstVGoogleVforVtrademarkVinfringement.VVuitton,VmakerVofVl
uxuryVluggage,Vhandbags,Vshoes,VandVotherVitems,VsuggestsVGoogle’sVsearchVengineVresultsVviolateVitsV
rights.
SearchVenginesVprovideVlinksVtoVsitesVrelatedVtoVtheVkeyVwordsVonVphrasesVenteredVbyVanVInternet
VsearchV user.VHowever,VGoogleVprovidesVlinksVtoVcompaniesVandVorganizationsVthatVpayVtoVbeVass
ociatedVwithVspecificVsearchVkeywords.VGoogleVhasVpostedVlinksVtoVcompanyVsitesVevenVwhenVtheV
keywordsVenteredVareVaVtrademarkVheldVbyVanotherVfirm.VInVaVsimilarVcaseVagainstVGoogle,VtwoVF
renchVfirmsVwereVawardedVdamagesVofV$89,000.VTheVcourtVrulingVstatedVthatVwhenVsearchesVareVe
nteredVonVregisteredVtrademarks,VGoogleV shouldV“findVtheVmeansVtoVblockVadvertisementsVbyVthird
VpartiesVwhoVhaveVnoVrightVtoVtheseVtrademarks.”VIfVappliedVbroadly,VthisVwouldVmeanVGoogleVma
yVneedVtoVlimitVtheVsitesVprovidedVwhenVaVsearchVoccursVonVaVtrademark,VandVforegoVsignificantV
advertisingVrevenueVfromVfirmsVwithoutVtrademarks.

Source:VAssociatedVPress,V“HandbagVMakerVVuittonVSuesVGoogle,”Vwww.cnn.com,VOctoberV24,V2003.


■ AnswersVtoVEven-NumberedVProblems
2.
IfVtheVfirmVcanVonlyVadvertiseVonceVinVtheVfirstVperiod,VitVshouldVadvertiseVuntilVtheVpr
esentVvalueVofVtheVincreaseVinVrevenueVresultingVfromVanVadditionalVunitVofVadvertisingVequals
VtheVcostVofVthatVunit.VWhenVcalculatingVtheVincreaseVinVrevenue,VtheVentireVperiodVoverVwhic
hVtheVadditionalVunitVofVadvertisingVstillVaffectsVsalesVshouldVbeVtakenVintoVaccount.VIfVadverti
singVcanVbeVrepeatedVoverVtime,VaVformalVdynamicVanalysisVisVnecessaryVtoVcalculateVtheVopti
malVrateVofVadvertisingVatVeachVmomentVinVtime,VtakingVaccountVofVtheVrateVatVwhichVconsum
ersVforget.

4. ConsumersVwhoVboughtVtheVmanufacturer’sVproductVanywayVmayVbeVworseVoffVifVtheVpriceVof
VtheVproductVisVraisedVtoVpayVforVincreasedVlocalVadvertising.VConsumersVwhoVwouldVnotVhav
eVbeenVawareV ofVtheVproduct,VonVtheVotherVhand,VmayVbeVbetterVoff.VTheVverticalVrestraintsVa
reVsociallyVdesirableVifVtheVadditionalVconsumerVsurplusVenjoyedVbyVtheVsecondVtypeVofVconsu
mersVplusVtheVadditionalVprofitsVofVbothVtheVdealersVandVtheVmanufacturerV(netVofVtheVincreas
edVcostVofVadvertising)VoutweighVtheVlossVinVconsumerVsurplusVofVtheVfirstVtypeVofVconsumers.


■ AdditionalVProblems
1. AreVtheVfollowingVproductsVprimarilyV(a)VsearchVgoodsV(b)VexperienceVgoods,VorV(c)VcredenceVgo
ods?
(i) packageVholidays
(ii) insurance
(iii) organicVproduce
(iv) vitaminVpills
(v) paperVclips

2. WhyVdoVadvertisementsVforVlawVfirmsVfocusVmoreVonVtheVcareVprovidedVtoVclientsVratherVt
hanVonVtheVspecificVcharacteristicsVofVtheVlawyers?

3. TheVU.S.VgovernmentVandVmanyVotherVgovernmentsVaidVexportingVindustriesVbyVsupplyi
ngVfreeVadvertisingVabroad.VIsVthisVsociallyVdesirable.
(i) fromVaVnationalVperspective;
(ii) fromVaV“global”Vperspective?
AssumeVthatVgovernmentsVdoVnotVhaveVaVcostVadvantageVoverVexportingVfirmsVinVprovidingVadver

,tisingVabroad.

, 54 Carlton/PerloffV V •V ModernVIndustrialVOrganization,VFourthVEdition,VGlobalVEdition


4. DescribeVthreeVexplanationsVofVhowVadvertisingVcanVbenefitVconsumers.

5. WhyVmightVsomeVclaimVadvertisingVforVaVparticularVbrandVofVsodium-chlorideVsaltVisVanticompetitive?

6. SupposeVantifraudVlawsVinVaVcertainVcountryVareVstrictlyVenforced,VwithVsubstantialVpenaltiesVfo
rVlying.VWhatVshouldVaVrationalVconsumerVinVthatVcountryVthenVconcludeVifVaVcerealVpackageV
saysVitV“containsVatVleastV5VouncesVofVcereal”?

7. AVmonopolyVfacesVtheVinverseVdemandVcurve,
bQV
pV=VaV− ,
V +V1
whereVVisVitsVlevelVofVitsVadvertising.VItsVmarginalVproductionVcostsVareVconstantVatVm.VSho
wVinVaVdiagramVwhatVhappensVtoVitsVprice,VrevenuesVandVproductionVcostsVifVitVraisesVadvertis
ingVfromVzeroVtoVoneVunit.VUnderVwhatVconditionVisVadvertisingVbyVtheVmonopolyVprofitable?

8. AVfirmVwithVproductionVcosts

3Q2
C(Q)V=V10
V+
8
facesVtheVdemandVcur
ve
2

QV=V36Vp−2V3V,
whereVVisVitsVlevelVofVadvertising.VOneVunitVofVadvertisingVcostsV$1.VFindVtheVfirm’sVoptimal
VoutputVlevelVandVlevelVofVadvertising.


9. AVfirmVwithVcostsVC(Q)V=V5,000V+V202QVfacesVtheVinverseVdemandVcurve
VV V V 
pV=V(400V−VQ)V +V1 ,
 100 
V 
whereVVisVitsVlevelVofVadvertising.VUseVconsumers’Vpre-
advertisingVpreferencesVtoVevaluateVtheVnetVsocialVgainVfromVtheVfirm’sVfirstVunitVofVadverti
sing,VifVthisVunitVcostsV$100.VThenVdoVtheVsameVusingVpost-
advertisingVpreferences.VIsVitVprofitableVforVtheVfirmVtoVadvertise?

10. AnVindustryVconsistsVofVtwoVidenticalVfirms,VwithVproductionVcostsVC(qi)V=V200V+V20qiV (iV=
V1,V2).VTheVinverseVmarketVdemandVcurveVis

pV=V100V−VQV+ 1 +V V 
,
whereViV isVFirmVi’sVadvertisingVexpenditure.VOneVunitVofVadvertisingVcostsV$1.VIfVtheVfirmsV
playVCournotVinVbothVoutputVandVadvertisingVlevels,VwhatVareVtheVequilibriumVvaluesVofVbothV
variables?

11. AVfirmVthatVengagesVinVadvertisingVhasVconstantVmarginalVproductionVcosts.VSupposeVdemandVi
sVweaklyVseparableVinVprice,Vp,VandVadvertisingVexpenditure,V:
D(p,V)V=Vd(p)g(),
DoesVthisVfunctionalVformVsimplifyVtheVfirm’sVdecisionVaboutVbothVvariables?V(Hint:VdoesVtheV
firmVhaveVtoVsolveVforVbothVvariablesVsimultaneously?)