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Advertising and Coordination

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  • Kyle Bagwell
  • Garey Ramey

Abstract

We show that when relevant market information such as price is difficult to communicate, advertising plays a key role in bringing about optimal coordination of purchase behavior: an efficient firm uses advertising expenditures in place of price to inform sophisticated consumers that it offers a better deal. This provides a theoretical explanation for Benham's (1972) empirical association of the ability to advertise with lower prices and larger scale. We find that advertising improves welfare unambiguously when firms' price choices are the only source of uncertainty. When advertising must also signal the identity of the efficient firm, however, a welfare tradeoff arises between advertising and coordination. Our results extend readily to situations of partial price observability and product quality uncertainty.

Suggested Citation

  • Kyle Bagwell & Garey Ramey, 1990. "Advertising and Coordination," Discussion Papers 903, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  • Handle: RePEc:nwu:cmsems:903
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    References listed on IDEAS

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    1. Kihlstrom, Richard E & Riordan, Michael H, 1984. "Advertising as a Signal," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 427-450, June.
    2. Kyle Bagwell & Garey Ramey, 1989. "Oligopoly Limit Pricing," Discussion Papers 829, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    3. Benham, Lee, 1972. "The Effect of Advertising on the Price of Eyeglasses," Journal of Law and Economics, University of Chicago Press, vol. 15(2), pages 337-352, October.
    4. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, pages 796-821.
    5. Kyle Bagwell & Garey Ramey, 1996. "Capacity, Entry, and Forward Induction," RAND Journal of Economics, The RAND Corporation, pages 660-680.
    6. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-841, August.
    7. Kyle Bagwell & Garey Ramey, 1991. "Oligopoly Limit Pricing," RAND Journal of Economics, The RAND Corporation, pages 155-172.
    8. In-Koo Cho & David M. Kreps, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, Oxford University Press, pages 179-221.
    9. Kyle Bagwell, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," Review of Economic Studies, Oxford University Press, vol. 54(3), pages 365-384.
    10. Jackson, Matthew & Moulin, Hervé, 1992. "Implementing a public project and distributing its cost," Journal of Economic Theory, Elsevier, pages 125-140.
    11. Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, University of Chicago Press, vol. 78(2), pages 311-329, March-Apr.
    12. Kyle Bagwell & Garey Ramey, 1990. "Capacity, Entry and Forward Induction," Discussion Papers 888, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    13. Cady, John F, 1976. "An Estimate of the Price Effects of Restrictions on Drug Price Advertising," Economic Inquiry, Western Economic Association International, vol. 14(4), pages 493-510, December.
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    Citations

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    Cited by:

    1. Paulson Gjerde, Kathy A. & Slotnick, Susan A., 2004. "Quality and reputation: The effects of external and internal factors over time," International Journal of Production Economics, Elsevier, vol. 89(1), pages 1-20, May.
    2. Witness Simbanegavi, 2008. "Loss leader or low margin leader? Advertising and the degree of product differentiation," Working Papers 105, Economic Research Southern Africa.
    3. Kyle Bagwell & Garey Ramey, 1992. "Coordination Economies," Discussion Papers 1034, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    4. Joel Waldfogel & Jeffrey Milyo, 1999. "The Effect of Price Advertising on Prices: Evidence in the Wake of 44 Liquormart," American Economic Review, American Economic Association, pages 1081-1096.
    5. Takaoka, Sumiko, 2005. "The effects of product liability costs on R&D with asymmetric information," Japan and the World Economy, Elsevier, pages 59-81.
    6. Pastine, Ivan & Pastine, Tuvana, 2005. "Coordination in Markets with Consumption Externalities: The Role of Advertising and Product Quality," CEPR Discussion Papers 5152, C.E.P.R. Discussion Papers.
    7. Nejadmalayeri, Ali & Mathur, Ike & Singh, Manohar, 2013. "Product market advertising and corporate bonds," Journal of Corporate Finance, Elsevier, pages 78-94.
    8. In, Younghwan & Wright, Julian, 2014. "Loss-leader pricing and upgrades," Economics Letters, Elsevier, vol. 122(1), pages 19-22.
    9. Dina Mayzlin & Yaniv Dover & Judith A. Chevalier, 2012. "Promotional Reviews: An Empirical Investigation of Online Review Manipulation," NBER Working Papers 18340, National Bureau of Economic Research, Inc.
    10. Schoonbeek, Lambert & Kooreman, Peter, 1999. "The impact of advertising in a duopoly model," Research Report 99B42, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    11. repec:dgr:rugsom:99b42 is not listed on IDEAS
    12. Dina Mayzlin & Jiwoong Shin, 2011. "Uninformative Advertising as an Invitation to Search," Marketing Science, INFORMS, vol. 30(4), pages 666-685, July.

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