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Coordination in Markets with Consumption Externalities : The Role of Advertising and Product Quality

  • Ivan Pastine

    ()

  • Tuvana Pastine

    ()

This paper studies advertising in vertically differentiated product markets with positive consumption externalities. In markets with consumption externalities, the value of the product to the consumer depends on the purchasing decisions of other consumers. In such markets, we show that firms will engage in advertising competition in order to convince consumers of their popularity only as long as they produce goods of similar quality. The firm with the lower quality product will have a greater incentive to advertise. If it is not the brand to provide the greater consumption externality it will have very low market share due to its low intrinsic quality. Hence, in equilibrium, the lower quality product will often be more popular. This provides an additional explanation for the empirical observation that in some markets high quality is associated with lower levels of advertising.

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Paper provided by Bilkent University, Department of Economics in its series Departmental Working Papers with number 0003.

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Date of creation: 2000
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Handle: RePEc:bil:bilpap:0003
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  1. Ivan Pastine & Tuvana Pastine, 2000. "Consumption Externalities, Coordination and Advertising," Departmental Working Papers 0002, Bilkent University, Department of Economics.
  2. Baye, Michael R & Kovenock, Dan & de Vries, Casper G, 1993. "Rigging the Lobbying Process: An Application of the All-Pay Auction," American Economic Review, American Economic Association, vol. 83(1), pages 289-94, March.
  3. 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.
  4. C. Robert Clark & Ignatius J. Horstmann, 2004. "Advertising and Coordination in Markets with Consumption Scale Effects," CIRANO Working Papers 2004s-35, CIRANO.
  5. Hao Zhao, 2000. "Raising Awareness and Signaling Quality to Uninformed Consumers: A Price-Advertising Model," Marketing Science, INFORMS, vol. 19(4), pages 390-396, January.
  6. Meurer, Michael & Stahl, Dale II, 1994. "Informative advertising and product match," International Journal of Industrial Organization, Elsevier, vol. 12(1), pages 1-19, March.
  7. Ignatius Horstmann & Sridhar Moorthy, 2003. "Advertising Spending and Quality for Services: The Role of Capacity," Quantitative Marketing and Economics, Springer, vol. 1(3), pages 337-365, September.
  8. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 796-821, August.
  9. Stahl II Dale O., 1994. "Oligopolistic Pricing and Advertising," Journal of Economic Theory, Elsevier, vol. 64(1), pages 162-177, October.
  10. Becker, Gary S, 1991. "A Note on Restaurant Pricing and Other Examples of Social Influences on Price," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 1109-16, October.
  11. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug..
  12. Becker, Gary S & Murphy, Kevin M, 1993. "A Simple Theory of Advertising as a Good or Bad," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 941-64, November.
  13. Karni, Edi & Levin, Dan, 1994. "Social Attributes and Strategic Equilibrium: A Restaurant Pricing Game," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 822-40, August.
  14. Yubo Chen & Jinhong Xie, 2005. "Third-Party Product Review and Firm Marketing Strategy," Marketing Science, INFORMS, vol. 24(2), pages 218-240, February.
  15. Porter, Michael E, 1976. "Interbrand Choice, Media Mix and Market Performance," American Economic Review, American Economic Association, vol. 66(2), pages 398-406, May.
  16. Stegeman, Mark, 1991. "Advertising in Competitive Markets," American Economic Review, American Economic Association, vol. 81(1), pages 210-23, March.
  17. Moorthy, S. & Zhao, H., 1995. "Advertising and Quality: An Empirical Analysis," Papers 95-04, Rochester, Business - Marketing Science.
  18. Robert, Jacques & Stahl, Dale O, II, 1993. "Informative Price Advertising in a Sequential Search Model," Econometrica, Econometric Society, vol. 61(3), pages 657-86, May.
  19. Avinash Dixit & Victor Norman, 1978. "Advertising and Welfare," Bell Journal of Economics, The RAND Corporation, vol. 9(1), pages 1-17, Spring.
  20. Grossman, Gene M & Shapiro, Carl, 1984. "Informative Advertising with Differentiated Products," Review of Economic Studies, Wiley Blackwell, vol. 51(1), pages 63-81, January.
  21. Bagwell, Kyle & Ramey, Garey, 1994. "Advertising and Coordination," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 153-72, January.
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