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Advertising and Limit Pricing

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  • Kyle Bagwell
  • Garey Ramey

Abstract

We enrich Milgrom and Roberts' (1982) limit-pricing model to allow an incumbent to signal his costs with both price and advertisements. Our fundamental result is that a cost-reducing distortion occurs, in that the incumbent behaves as if there were complete information but his costs were lower than they are. Preentry price is therefore distorted downward, and demand-enhancing advertising is distorted upward, as a consequence of signalling. If advertising is a purely dissipative signal, it is not used, nor therefore distorted. Recent refinements of the sequential equilibrium concept are featured.

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Bibliographic Info

Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 19 (1988)
Issue (Month): 1 (Spring)
Pages: 59-71

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Handle: RePEc:rje:randje:v:19:y:1988:i:spring:p:59-71

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References

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  1. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug..
  2. Butters, Gerard R, 1977. "Equilibrium Distributions of Sales and Advertising Prices," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 44(3), pages 465-91, October.
  3. Kyle Bagwell, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 722, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 709, Cowles Foundation for Research in Economics, Yale University.
  5. Milgrom, Paul & Roberts, John, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica, Econometric Society, Econometric Society, vol. 50(2), pages 443-59, March.
  6. Salop, Steven C, 1979. "Strategic Entry Deterrence," American Economic Review, American Economic Association, American Economic Association, vol. 69(2), pages 335-38, May.
  7. Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 78(2), pages 311-29, March-Apr.
  8. Kihlstrom, Richard E & Riordan, Michael H, 1984. "Advertising as a Signal," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 92(3), pages 427-50, June.
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Citations

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Cited by:
  1. Kyle Bagwell, 1991. "Pricing to Signal Product Line Quality," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 921, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Wang, Shinn-Shyr & Stiegert, Kyle W., 2006. "The Duopolistic Firm with Endogenous Risk Control: Case of Persuasive Advertising and Product Differentiation," Staff Paper Series, University of Wisconsin, Agricultural and Applied Economics 496, University of Wisconsin, Agricultural and Applied Economics.
  3. Srihari Govindan & Robert Wilson, 2007. "'On Forward Induction," Levine's Working Paper Archive 321307000000000825, David K. Levine.
  4. Cesaltina Pires & Sílvia Jorge, 2012. "Limit pricing under third-degree price discrimination," International Journal of Game Theory, Springer, Springer, vol. 41(3), pages 671-698, August.
  5. Kyle Bagwell, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 722, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Victor Tremblay & Stephen Polasky, 2002. "Advertising with Subjective Horizontal and Vertical Product Differentiation," Review of Industrial Organization, Springer, Springer, vol. 20(3), pages 253-265, May.
  7. Govindan, Srihari & Wilson, Robert B., 2008. "Decision-Theoretic Forward Induction," Research Papers, Stanford University, Graduate School of Business 1986, Stanford University, Graduate School of Business.
  8. Claude D. Fluet & Paolo G. Garella, 1995. "Advertising as a Signal of Quality, A New Explanation," Working Papers, Dipartimento Scienze Economiche, Universita' di Bologna 231, Dipartimento Scienze Economiche, Universita' di Bologna.
  9. Doh-Shin Jeon & Joel Shapiro, 2004. "Downsizing, job insecurity and firm reputation," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 795, Department of Economics and Business, Universitat Pompeu Fabra.
  10. Kyle Bagwell, 1991. "Competitive Limit Pricing Under Imperfect Information," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 954, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Fruchter, Gila E. & Messinger, Paul R., 2003. "Optimal management of fringe entry over time," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(3), pages 445-466, December.
  12. Kyle Bagwell & Robert W. Staiger, 1988. "Private Cost Information and the Multinational Enterprise," NBER Working Papers 2657, National Bureau of Economic Research, Inc.
  13. Meng, Dawen & Tian, Guoqiang, 2013. "Entry-Deterring Nonlinear Pricing with Bounded Rationality," MPRA Paper 57935, University Library of Munich, Germany, revised May 2014.
  14. John G. Riley, 2001. "Silver Signals: Twenty-Five Years of Screening and Signaling," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 39(2), pages 432-478, June.
  15. Andrea Mantovani & Giordano Mion, 2006. "Advertising and endogenous exit in a differentiated duopoly," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 42665, London School of Economics and Political Science, LSE Library.

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