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Advertising as Distortion of Learning in Markets with Network Externalities

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  • Brekke, Kjell Arne

    ()
    (The Ragnar Frisch Centre for Economic Research)

  • Rege, Mari

    ()
    (University of Stavanger)

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    Abstract

    We present a theory of how advertising can break a lock-in by distorting beliefs about market shares in markets with network externalities. On the background of the availability heuristic we assume that people learn about market shares by observing product adoption of others, but are not able to fully distinguish between observations of real people and …ctitious characters in advertisements. We look at a game between an incumbent and an entrant producing close substitutes. Our analysis shows that if the entrant’s product is of su¢ ciently high quality, then the entrant will use advertising in order to break the lock-in and the incumbent will not advertise at all. However, if the quality di¤erential between the two products is small, then the incumbent may advertise and make it unpro…table for the entrant to break the lock-in.

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    File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2006/Memo-24-2006.pdf
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    Bibliographic Info

    Paper provided by Oslo University, Department of Economics in its series Memorandum with number 24/2006.

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    Length: 28 pages
    Date of creation: 23 Nov 2006
    Date of revision:
    Handle: RePEc:hhs:osloec:2006_024

    Contact details of provider:
    Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
    Phone: 22 85 51 27
    Fax: 22 85 50 35
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    Web page: http://www.oekonomi.uio.no/indexe.html
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    Related research

    Keywords: Advertising; availability heuristic; herding behavior; information; lock-in;

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    1. Schmalensee, Richard, 1983. "Advertising and Entry Deterrence: An Exploratory Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 636-53, August.
    2. Joseph Farrell & Garth Saloner, 1986. "Installed Base and Compatibility, With Implications for Product Preannouncements," Working papers 411, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. Ivan Pastine & Tuvana Pastine, 2000. "Consumption Externalities, Coordination and Advertising," Departmental Working Papers 0002, Bilkent University, Department of Economics.
    4. Xavier Gabaix & David Laibson, 2006. "Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 505-540, May.
    5. Katz, Michael L & Shapiro, Carl, 1992. "Product Introduction with Network Externalities," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 55-83, March.
    6. Needham, Douglas, 1976. "Entry Barriers and Non-Price Aspects of Firms' Behavior," Journal of Industrial Economics, Wiley Blackwell, vol. 25(1), pages 29-43, September.
    7. Salop, Steven C, 1979. "Strategic Entry Deterrence," American Economic Review, American Economic Association, vol. 69(2), pages 335-38, May.
    8. Bagwell, Kyle & Ramey, Garey, 1990. "Advertising and pricing to deter or accommodate entry when demand is unknown," International Journal of Industrial Organization, Elsevier, vol. 8(1), pages 93-113.
    9. repec:att:wimass:9325 is not listed on IDEAS
    10. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
    11. Gale, John & Binmore, Kenneth G. & Samuelson, Larry, 1995. "Learning to be imperfect: The ultimatum game," Games and Economic Behavior, Elsevier, vol. 8(1), pages 56-90.
    12. Spence, A Michael, 1980. "Notes on Advertising, Economies of Scale, and Entry Barriers," The Quarterly Journal of Economics, MIT Press, vol. 95(3), pages 493-507, November.
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