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Loss leader or low margin leader? Advertising and the degree of product differentiation

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  • Witness Simbanegavi

Abstract

This paper attempts to isolate the conditions that give rise to loss leader pricing. I show that for sufficiently low distance between firms, the advertised good is priced below cost irrespective of whether firms advertise the same or different products. Instead, if products are sufficiently differentiated, loss leader pricing may result only if firms advertise the low reservation value product, otherwise the advertised good is a low margin leader. Thus, whether the advertised good is a loss leader or a low margin leader is primarily a function of the extent of differentiation between competing firms.

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Bibliographic Info

Paper provided by Economic Research Southern Africa in its series Working Papers with number 105.

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Date of creation: 2008
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Handle: RePEc:rza:wpaper:105

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Keywords: Informative advertising; loss leader; low margin leader; product di¤erentiation;

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  1. Grossman, Gene M & Shapiro, Carl, 1984. "Informative Advertising with Differentiated Products," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 51(1), pages 63-81, January.
  2. Jeffrey Milyo & Joel Waldfogel, 1998. "The Effect of Price Advertising and Prices: Evidence in the Wake of 44 Liquormart," NBER Working Papers 6488, National Bureau of Economic Research, Inc.
  3. Glenn Ellison, 2004. "A Model of Add-on Pricing," Economics Working Papers, Institute for Advanced Study, School of Social Science 0049, Institute for Advanced Study, School of Social Science.
  4. Bagwell, Kyle & Ramey, Garey, 1994. "Advertising and Coordination," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(1), pages 153-72, January.
  5. David A. Soberman, 2004. "Research Note: Additional Learning and Implications on the Role of Informative Advertising," Management Science, INFORMS, INFORMS, vol. 50(12), pages 1744-1750, December.
  6. Bagwell, Kyle & Ramey, Garey, 1994. "Coordination Economies, Advertising, and Search Behavior in Retail Markets," American Economic Review, American Economic Association, American Economic Association, vol. 84(3), pages 498-517, June.
  7. James D. Hess & Eitan Gerstner, 1987. "Loss Leader Pricing and Rain Check Policy," Marketing Science, INFORMS, INFORMS, vol. 6(4), pages 358-374.
  8. Benham, Lee, 1972. "The Effect of Advertising on the Price of Eyeglasses," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 15(2), pages 337-52, October.
  9. Witness Simbanegavi, 2005. "Equilibrium Pricing When Only Some Goods Are Advertised," Working Papers, Economic Research Southern Africa 35, Economic Research Southern Africa.
  10. Lal, Rajiv & Matutes, Carmen, 1994. "Retail Pricing and Advertising Strategies," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 67(3), pages 345-70, July.
  11. DeGraba, Patrick, 2006. "The loss leader is a turkey: Targeted discounts from multi-product competitors," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 24(3), pages 613-628, May.
  12. Butters, Gerard R, 1977. "Equilibrium Distributions of Sales and Advertising Prices," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 44(3), pages 465-91, October.
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