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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.

Suggested Citation

  • Kyle Bagwell & Garey Ramey, 1988. "Advertising and Limit Pricing," RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 59-71, Spring.
    • Handle: RePEc:rje:randje:v:19:y:1988:i:spring:p:59-71
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    1. Milgrom, Paul & Roberts, John, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica, Econometric Society, vol. 50(2), pages 443-459, March.
    2. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 796-821, August.
    3. Kyle Bagwell, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 54(3), pages 365-384.
    4. Salop, Steven C, 1979. "Strategic Entry Deterrence," American Economic Review, American Economic Association, vol. 69(2), pages 335-338, May.
    5. Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, University of Chicago Press, vol. 78(2), pages 311-329, March-Apr.
    6. Kihlstrom, Richard E & Riordan, Michael H, 1984. "Advertising as a Signal," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 427-450, June.
    7. Moulin, Herve, 1994. "Social choice," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 2, chapter 31, pages 1091-1125, Elsevier.
    8. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-754, July/Aug..
    9. Gerard R. Butters, 1977. "Equilibrium Distributions of Sales and Advertising Prices," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 44(3), pages 465-491.
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