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Coordination in Markets with Consumption Externalities : The Role of Advertising and Product Quality

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  • Ivan Pastine

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  • Tuvana Pastine

    ()

Abstract

This paper studies advertising in vertically differentiated product markets with positive consumption externalities. In markets with consumption externalities, the value of the product to the consumer depends on the purchasing decisions of other consumers. In such markets, we show that firms will engage in advertising competition in order to convince consumers of their popularity only as long as they produce goods of similar quality. The firm with the lower quality product will have a greater incentive to advertise. If it is not the brand to provide the greater consumption externality it will have very low market share due to its low intrinsic quality. Hence, in equilibrium, the lower quality product will often be more popular. This provides an additional explanation for the empirical observation that in some markets high quality is associated with lower levels of advertising.

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Bibliographic Info

Paper provided by Bilkent University, Department of Economics in its series Departmental Working Papers with number 0003.

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Date of creation: 2000
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Handle: RePEc:bil:bilpap:0003

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  1. Pastine, Ivan & Pastine, Tuvana, 2001. "Consumption Externalities, Coordination and Advertising," CEPR Discussion Papers 2867, C.E.P.R. Discussion Papers.
  2. Baye, Michael R & Kovenock, Dan & de Vries, Casper G, 1993. "Rigging the Lobbying Process: An Application of the All-Pay Auction," American Economic Review, American Economic Association, vol. 83(1), pages 289-94, March.
  3. Robert, Jacques & Stahl, Dale O, II, 1993. "Informative Price Advertising in a Sequential Search Model," Econometrica, Econometric Society, vol. 61(3), pages 657-86, May.
  4. Meurer, Michael & Stahl, Dale II, 1994. "Informative advertising and product match," International Journal of Industrial Organization, Elsevier, vol. 12(1), pages 1-19, March.
  5. Gary S. Becker, 1991. "A Note on Restaurant Pricing and Other Examples of Social Influences on Price," University of Chicago - George G. Stigler Center for Study of Economy and State 67, Chicago - Center for Study of Economy and State.
  6. Ignatius Horstmann & Sridhar Moorthy, 2003. "Advertising Spending and Quality for Services: The Role of Capacity," Quantitative Marketing and Economics, Springer, vol. 1(3), pages 337-365, September.
  7. Kihlstrom, Richard E & Riordan, Michael H, 1984. "Advertising as a Signal," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 427-50, June.
  8. Moorthy, S. & Zhao, H., 1995. "Advertising and Quality: An Empirical Analysis," Papers 95-04, Rochester, Business - Marketing Science.
  9. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug..
  10. Porter, Michael E, 1976. "Interbrand Choice, Media Mix and Market Performance," American Economic Review, American Economic Association, vol. 66(2), pages 398-406, May.
  11. 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.
  12. Grossman, Gene M & Shapiro, Carl, 1984. "Informative Advertising with Differentiated Products," Review of Economic Studies, Wiley Blackwell, vol. 51(1), pages 63-81, January.
  13. Stahl II Dale O., 1994. "Oligopolistic Pricing and Advertising," Journal of Economic Theory, Elsevier, vol. 64(1), pages 162-177, October.
  14. C. Robert Clark & Ignatius J. Horstmann, 2004. "Advertising and Coordination in Markets with Consumption Scale Effects," CIRANO Working Papers 2004s-35, CIRANO.
  15. Kyle Bagwell & Garey Ramey, 1990. "Advertising and Coordination," Discussion Papers 903, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  16. Avinash Dixit & Victor Norman, 1978. "Advertising and Welfare," Bell Journal of Economics, The RAND Corporation, vol. 9(1), pages 1-17, Spring.
  17. Becker, Gary S & Murphy, Kevin M, 1993. "A Simple Theory of Advertising as a Good or Bad," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 941-64, November.
  18. Karni, Edi & Levin, Dan, 1994. "Social Attributes and Strategic Equilibrium: A Restaurant Pricing Game," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 822-40, August.
  19. Stegeman, Mark, 1991. "Advertising in Competitive Markets," American Economic Review, American Economic Association, vol. 81(1), pages 210-23, March.
  20. Yubo Chen & Jinhong Xie, 2005. "Third-Party Product Review and Firm Marketing Strategy," Marketing Science, INFORMS, vol. 24(2), pages 218-240, February.
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Cited by:
  1. Ivan Pastine & Tuvana Pastine, 2002. "Comsumption Externalities, Coordination, and Advertising," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(3), pages 919-943, August.

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