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Modest Advertising Signals Strength

  • Ram Orzach

    (School of Industrial Engineering and Management, Ben-Gurion University of the Negeve)

  • Per Baltzer Overgaard

    (School of Economics and Management, University of Aarhus)

  • Yair Tauman

    (Center for Game Theory in Economics, SUNY)

This paper presents a signaling model where both price and advertising expenditures are used as signals of the initially unobservable quality of a newly introduced experience good. Consumers can be either "fastidious" or "indifferent". Fastidious individuals place a greater value on a high-quality product and a lesser value on the low-quality product than do indifferent individuals. It is shown that a sensible separating equilibrium exists where both firms set their full information prices. However, the high-quality firm cuts advertising expenditures 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 positively to advertising cuts and correctly identify the product quality. Hence, modest advertising may signal high quality.

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Paper provided by University of Copenhagen. Department of Economics. Centre for Industrial Economics in its series CIE Discussion Papers with number 2001-02.

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Length: 30 pages
Date of creation: Apr 2001
Date of revision:
Handle: RePEc:kud:kuieci:2001-02
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