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The Duopolistic Firm with Endogenous Risk Control: Case of Persuasive Advertising and Product Differentiation

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Author Info
Wang, Shinn-Shyr
Stiegert, Kyle W.
Abstract

In this paper, a two-period game is constructed, where duopoly firms choose advertising strategies in the first period and compete in price or quantity in the second period by maximizing the value of firm equity. Using certainty equivalence, we demonstrate the impacts of uncertainty and modes of competition on duopoly firms' optimal pricing, production, and advertising strategies. Equilibrium price and quantity outcomes emerge as significantly different from the standard industrial organization model of profit maximization. It turns out that the common measurement of market power, the Lerner index, is generally mis-stated. In contrast to the literature, we also find that firms will optimally switch from quantity to price competition either when advertising costs are low, demand is high, or if idiosyncratic risk is reduced. A series of simulations confirm these findings.

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Paper provided by University of Wisconsin, Agricultural and Applied Economics in its series Staff Paper Series with number 496.

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Date of creation: Mar 2006
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Handle: RePEc:ecl:wisagr:496

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D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection

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  1. Paul Klemperer & Margaret Meyer, 1986. "Price Competition vs. Quantity Competition: The Role of Uncertainty," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 618-638, Winter. [Downloadable!] (restricted)
  2. Wang, Shinn-Shyr & Stiegert, Kyle W. & Dhar, Tirtha, 2005. "Strategic Pricing Behavior under Asset Value Maximization," 2005 Annual meeting, July 24-27, Providence, RI 19198, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  3. Nirvikar Singh & Xavier Vives, 1984. "Price and Quantity Competition in a Differentiated Duopoly," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 546-554, Winter. [Downloadable!] (restricted)
  4. Motta, Massimo, 1993. "Endogenous Quality Choice: Price vs. Quantity Competition," Journal of Industrial Economics, Blackwell Publishing, vol. 41(2), pages 113-31, June. [Downloadable!] (restricted)
  5. Kyle Bagwell & Garey Ramey, 1988. "Advertising and Limit Pricing," RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 59-71, Spring. [Downloadable!] (restricted)
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  6. 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. [Downloadable!] (restricted)
  7. Avinash Dixit & Victor Norman, 1980. "Advertising and Welfare: Another Reply," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 753-754, Autumn. [Downloadable!] (restricted)
  8. Kaplan, Steven N & Ruback, Richard S, 1995. " The Valuation of Cash Flow Forecasts: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 50(4), pages 1059-93, September. [Downloadable!] (restricted)
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  9. Avinash Dixit, 1979. "A Model of Duopoly Suggesting a Theory of Entry Barriers," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 20-32, Spring. [Downloadable!] (restricted)
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  10. Leland, Hayne E, 1972. "Theory of the Firm Facing Uncertain Demand," American Economic Review, American Economic Association, vol. 62(3), pages 278-91, June. [Downloadable!] (restricted)
  11. Mark J. Roberts & Larry Samuelson, 1988. "An Empirical Analysis of Dynamic, Nonprice Competition in an Oligopolistic Industry," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 200-220, Summer. [Downloadable!] (restricted)
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  12. 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. [Downloadable!] (restricted)
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  13. Lester G. Telser, 1964. "Advertising and Competition," Journal of Political Economy, University of Chicago Press, vol. 72, pages 537. [Downloadable!] (restricted)
  14. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug.. [Downloadable!] (restricted)
  15. Avinash Dixit & Victor D. Norman, 1979. "Advertising and Welfare: Reply," Bell Journal of Economics, The RAND Corporation, vol. 10(2), pages 728-729, Autumn. [Downloadable!] (restricted)
  16. George J. Stigler, 1961. "The Economics of Information," Journal of Political Economy, University of Chicago Press, vol. 69, pages 213. [Downloadable!] (restricted)
  17. Avinash Dixit & Victor Norman, 1978. "Advertising and Welfare," Bell Journal of Economics, The RAND Corporation, vol. 9(1), pages 1-17, Spring. [Downloadable!] (restricted)
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