H3: Advertising and entry deterrence
=> Start again from hotelling model, will keep adding
=> Advertising can inform, but also persuade consumers to purchase certain
products
=> Even better than differentiating yourself from competitors, is not facing any
=> blocking entry might be optimal
Advertising
=> Wide variety in firm advertising behaviour
General data patterns
- Correlation between advertising and market power (markups)
- Persistence of advertising behaviour within industries: firms that spend a lot
on advertising today are likely to also do so next year
- Large differences across sectors: automotive and household product firms
most
3 Main views on consumer behaviour on advertising
- Persuasive advertising: ads change preferences, reorder products’ ranking
- Complementary advertising: ads compliment the utility from a product
- Informative advertising: ads inform consumer on products and their
characteristics => advertising is a signal: ads are wasteful, but lavish
expenses are a credible signal of quality (theory for informative)
- Not 1 right one, bit of everything, they overlap as well
Persuasive advertising
- Changing preferences of consumers
- Can create brand loyalty and (perceived) product differentiation
- Demand becomes less elastic: not as responsive to prices, less mark-ups,
because the advertisement persuaded them that a particular product is great
- Companies can then invest in advertising to create barriers to entry
- Economies of scale: large firms, concentrated market
- Consumer welfare: Advertising is likely bad for consumers
Informative advertising
- Informs consumer about products and their characteristics
- Could be direct or indirect
- Many markets are characterized by imperfect customer information (e.g.
search costs
- Demand becomes more elastic: consumers are aware of other products
- Advertising can facilitate entry: new firms can make consumers aware of them
- Consumer welfare: advertising is likely good for consumers
1
, Complementary advertising
- Enter directly into preferences in a way that enhances the value of certain
goods => Not persuasive, might be informative, but not necessarily
- Example: at wine sale, they give a lecture about how it is made and why it is
meaningful => complementary information
- Demand might become more elastic for low-volume (new) customers
=> potential customers to enter the market
- Advertising can facilitate entry: new firms can make consumers
aware/appreciate their product
- Consumer welfare: It depends, generally good
=> No single view is valid in all settings, difficult to distinguish the three views
Example informative advertising
=> Framework: standard Hotelling duopoly model of product differentiation
- N consumers distributed uniformly along a line
- Two firms located at end points of the line (l=0 and l=1)
- Each consumer is willing to pay at most r
- Transportation cost τ
- Marginal cost of production is c
=> Add to model:
- Not all N consumers know both goods
- Advertising makes consumers aware that your good exists
New added
- You have firm at point 1 and a firm at point 2
- λi = the fraction of all N consumers know their product
=> Each firm i can advertise to get to this fraction
- A(λi) = 1/2aλ2i N (Function of i’s cost of advertising to λiN consumers)
- Assume consumers remain uniformed: advertising is not too cheap a>τ/2
(otherwise all consumers know both firms, back to regular Hotelling model)
- Assume that all the probability that a consumer is informed is independent of
her location or her knowledge of other products
Customers will be divided between:
- Fraction λ1(1 - λ2) of consumers only knows about the product of firm 1
- Fraction λ2(1 - λ1) of consumers only knows about the product of firm 2
- Fraction λ1λ2 knows both products
- Fraction (1 - λ1)(1 - λ2) knows neither product => won’t purchase anything
2
=> Start again from hotelling model, will keep adding
=> Advertising can inform, but also persuade consumers to purchase certain
products
=> Even better than differentiating yourself from competitors, is not facing any
=> blocking entry might be optimal
Advertising
=> Wide variety in firm advertising behaviour
General data patterns
- Correlation between advertising and market power (markups)
- Persistence of advertising behaviour within industries: firms that spend a lot
on advertising today are likely to also do so next year
- Large differences across sectors: automotive and household product firms
most
3 Main views on consumer behaviour on advertising
- Persuasive advertising: ads change preferences, reorder products’ ranking
- Complementary advertising: ads compliment the utility from a product
- Informative advertising: ads inform consumer on products and their
characteristics => advertising is a signal: ads are wasteful, but lavish
expenses are a credible signal of quality (theory for informative)
- Not 1 right one, bit of everything, they overlap as well
Persuasive advertising
- Changing preferences of consumers
- Can create brand loyalty and (perceived) product differentiation
- Demand becomes less elastic: not as responsive to prices, less mark-ups,
because the advertisement persuaded them that a particular product is great
- Companies can then invest in advertising to create barriers to entry
- Economies of scale: large firms, concentrated market
- Consumer welfare: Advertising is likely bad for consumers
Informative advertising
- Informs consumer about products and their characteristics
- Could be direct or indirect
- Many markets are characterized by imperfect customer information (e.g.
search costs
- Demand becomes more elastic: consumers are aware of other products
- Advertising can facilitate entry: new firms can make consumers aware of them
- Consumer welfare: advertising is likely good for consumers
1
, Complementary advertising
- Enter directly into preferences in a way that enhances the value of certain
goods => Not persuasive, might be informative, but not necessarily
- Example: at wine sale, they give a lecture about how it is made and why it is
meaningful => complementary information
- Demand might become more elastic for low-volume (new) customers
=> potential customers to enter the market
- Advertising can facilitate entry: new firms can make consumers
aware/appreciate their product
- Consumer welfare: It depends, generally good
=> No single view is valid in all settings, difficult to distinguish the three views
Example informative advertising
=> Framework: standard Hotelling duopoly model of product differentiation
- N consumers distributed uniformly along a line
- Two firms located at end points of the line (l=0 and l=1)
- Each consumer is willing to pay at most r
- Transportation cost τ
- Marginal cost of production is c
=> Add to model:
- Not all N consumers know both goods
- Advertising makes consumers aware that your good exists
New added
- You have firm at point 1 and a firm at point 2
- λi = the fraction of all N consumers know their product
=> Each firm i can advertise to get to this fraction
- A(λi) = 1/2aλ2i N (Function of i’s cost of advertising to λiN consumers)
- Assume consumers remain uniformed: advertising is not too cheap a>τ/2
(otherwise all consumers know both firms, back to regular Hotelling model)
- Assume that all the probability that a consumer is informed is independent of
her location or her knowledge of other products
Customers will be divided between:
- Fraction λ1(1 - λ2) of consumers only knows about the product of firm 1
- Fraction λ2(1 - λ1) of consumers only knows about the product of firm 2
- Fraction λ1λ2 knows both products
- Fraction (1 - λ1)(1 - λ2) knows neither product => won’t purchase anything
2
