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Advertising and Collusion in Retail Markets

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  • Gea Myoung Lee

    ()
    (School of Economics, Singapore Management University)

  • Kyle Bagwell

    ()
    (Department of Economics, Standford University)

Abstract

We consider non-price advertising by retail firms that are privately informed as to their respective production costs. We first analyze a static model. We construct an advertising equilibrium, in which informed consumers use an advertising search rule whereby they buy from the highest-advertising firm. Consumers are rational in using the advertising search rule, since the lowest-cost firm advertises the most and also selects the lowest price. Even though the advertising equilibrium facilitates productive efficiency, we establish conditions under which firms enjoy higher expected profit when advertising is banned. Consumer welfare falls in this case, however.We next analyze a dynamic model in which privately informed firms interact repeatedly. In this setting, firms may achieve a collusive equilibrium in which they limit the use of advertising, and we establish conditions under which optimal collusion entails pooling at zero advertising. More generally, full or partial pooling is observed in optimal collusion. In summary, non-price advertising can promote product efficiency and raise consumer welfare; however, firms often have incentive to diminish advertising competition, whether through regulatory restrictions or collusion.

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Bibliographic Info

Paper provided by Singapore Management University, School of Economics in its series Working Papers with number 09-2008.

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Length: 52 pages
Date of creation: Mar 2008
Date of revision:
Publication status: Published in SMU Economics and Statistics Working Paper Series
Handle: RePEc:siu:wpaper:09-2008

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Cited by:
  1. Gea Myoung Lee, 2008. "Optimal Collusion with Internal Contracting," Working Papers 08-2008, Singapore Management University, School of Economics.
  2. Condorelli, Daniele, 2012. "What money canʼt buy: Efficient mechanism design with costly signals," Games and Economic Behavior, Elsevier, vol. 75(2), pages 613-624.

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