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Loss leader or low margin leader? Advertising and the degree of product differentiation

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  • Witness Simbanegavi

Abstract

This paper attempts to isolate the conditions that give rise to loss leader pricing. I show that for sufficiently low distance between firms, the advertised good is priced below cost irrespective of whether firms advertise the same or different products. Instead, if products are sufficiently differentiated, loss leader pricing may result only if firms advertise the low reservation value product, otherwise the advertised good is a low margin leader. Thus, whether the advertised good is a loss leader or a low margin leader is primarily a function of the extent of differentiation between competing firms.

Suggested Citation

  • Witness Simbanegavi, 2008. "Loss leader or low margin leader? Advertising and the degree of product differentiation," Working Papers 105, Economic Research Southern Africa.
  • Handle: RePEc:rza:wpaper:105
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    File URL: http://www.econrsa.org/node/129
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    References listed on IDEAS

    as
    1. 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.
    2. Glenn Ellison, 2005. "A Model of Add-On Pricing," The Quarterly Journal of Economics, Oxford University Press, vol. 120(2), pages 585-637.
    3. Witness Simbanegavi, 2005. "Equilibrium Pricing When Only Some Goods Are Advertised," Working Papers 35, Economic Research Southern Africa.
    4. David A. Soberman, 2004. "Research Note: Additional Learning and Implications on the Role of Informative Advertising," Management Science, INFORMS, vol. 50(12), pages 1744-1750, December.
    5. Bagwell, Kyle & Ramey, Garey, 1994. "Coordination Economies, Advertising, and Search Behavior in Retail Markets," American Economic Review, American Economic Association, vol. 84(3), pages 498-517, June.
    6. James D. Hess & Eitan Gerstner, 1987. "Loss Leader Pricing and Rain Check Policy," Marketing Science, INFORMS, vol. 6(4), pages 358-374.
    7. DeGraba, Patrick, 2006. "The loss leader is a turkey: Targeted discounts from multi-product competitors," International Journal of Industrial Organization, Elsevier, vol. 24(3), pages 613-628, May.
    8. Gene M. Grossman & Carl Shapiro, 1984. "Informative Advertising with Differentiated Products," Review of Economic Studies, Oxford University Press, vol. 51(1), pages 63-81.
    9. 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.
    10. Kyle Bagwell & Garey Ramey, 1994. "Advertising and Coordination," Review of Economic Studies, Oxford University Press, vol. 61(1), pages 153-171.
    11. Lal, Rajiv & Matutes, Carmen, 1994. "Retail Pricing and Advertising Strategies," The Journal of Business, University of Chicago Press, vol. 67(3), pages 345-370, July.
    12. Gerard R. Butters, 1977. "Equilibrium Distributions of Sales and Advertising Prices," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 465-491.
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    More about this item

    Keywords

    Informative advertising; loss leader; low margin leader; product di¤erentiation;

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • M37 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Marketing and Advertising - - - Advertising

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