Modest Advertising Signals Strength
We reexamine the role of prices and advertising expenditures as signals of quality. Consumers are either ``fastidious'' or ``indifferent.'' Fastidious individuals value high quality more and low quality less than do indifferent individuals. Then a sensible and robust separating equilibrium exists in which both types set their full-information prices. However, the high-quality firm cuts advertising below the full-information level of the low-quality firm, even if the full-information advertising expenditures of the high-quality firm are larger than those of the low-quality firm. Consumers respond favorably to advertising cuts and correctly identify quality. Hence, modest advertising may signal high quality.
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Volume (Year): 33 (2002)
Issue (Month): 2 (Summer)
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