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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

Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 729.

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Date of creation: Apr 1987
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Handle: RePEc:nwu:cmsems:729

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Postal: Center for Mathematical Studies in Economics and Management Science, Northwestern University, 580 Jacobs Center, 2001 Sheridan Road, Evanston, IL 60208-2014
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Web page: http://www.kellogg.northwestern.edu/research/math/
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References

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  1. Butters, Gerard R, 1977. "Equilibrium Distributions of Sales and Advertising Prices," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 465-91, October.
  2. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
  3. Milgrom, Paul & Roberts, John, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica, Econometric Society, vol. 50(2), pages 443-59, March.
  4. Kyle Bagwell, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," Discussion Papers 722, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Salop, Steven C, 1979. "Strategic Entry Deterrence," American Economic Review, American Economic Association, vol. 69(2), pages 335-38, May.
  6. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug..
  7. Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, 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, vol. 92(3), pages 427-50, June.
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Cited by:
  1. Srihari Govindan & Robert Wilson, 2009. "On Forward Induction," Econometrica, Econometric Society, vol. 77(1), pages 1-28, 01.
  2. Claude D. Fluet & Paolo G. Garella, 1995. "Advertising as a Signal of Quality, A New Explanation," Working Papers 231, Dipartimento Scienze Economiche, Universita' di Bologna.
  3. Cesaltina Pires & Sílvia Jorge, 2012. "Limit pricing under third-degree price discrimination," International Journal of Game Theory, Springer, vol. 41(3), pages 671-698, August.
  4. Kyle Bagwell & Robert W. Staiger, 1988. "Private Cost Information and the Multinational Enterprise," NBER Working Papers 2657, National Bureau of Economic Research, Inc.
  5. Kyle Bagwell, 1991. "Competitive Limit Pricing Under Imperfect Information," Discussion Papers 954, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. John G. Riley, 2001. "Silver Signals: Twenty-Five Years of Screening and Signaling," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 432-478, June.
  7. Victor Tremblay & Stephen Polasky, 2002. "Advertising with Subjective Horizontal and Vertical Product Differentiation," Review of Industrial Organization, Springer, vol. 20(3), pages 253-265, May.
  8. Andrea Mantovani & Giordano Mion, 2006. "Advertising and endogenous exit in a differentiated duopoly," LSE Research Online Documents on Economics 42665, London School of Economics and Political Science, LSE Library.
  9. Govindan, Srihari & Wilson, Robert B., 2008. "Decision-Theoretic Forward Induction," Research Papers 1986, Stanford University, Graduate School of Business.
  10. Doh-Shin Jeon & Joel Shapiro, 2004. "Downsizing, job insecurity and firm reputation," Economics Working Papers 795, Department of Economics and Business, Universitat Pompeu Fabra.
  11. Fruchter, Gila E. & Messinger, Paul R., 2003. "Optimal management of fringe entry over time," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 445-466, December.
  12. Wang, Shinn-Shyr & Stiegert, Kyle W., 2006. "The Duopolistic Firm with Endogenous Risk Control: Case of Persuasive Advertising and Product Differentiation," Staff Paper Series 496, University of Wisconsin, Agricultural and Applied Economics.
  13. Kyle Bagwell, 1991. "Pricing to Signal Product Line Quality," Discussion Papers 921, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Bagwell, Kyle, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," Review of Economic Studies, Wiley Blackwell, vol. 54(3), pages 365-84, July.

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