A Structural Model of Advertising Signaling and Social Learning: The Case of the Motion Picture Industry

This paper empirically studies how social learning among consumers shapes firms' optimal strategies of using advertising to signal product quality. I present an equilibrium model that describes both consumers and firms'learning and decision-making under quality uncertainty. My model allows me to distinguish between two roles of informative advertising reaching consumers and signaling product quality. I apply the model to the U.S. motion picture theatrical market where advertising and social learning are two main factors for a new movie's success. The structural estimates imply that movie studios signaling advertising only helps to reduce consumers' uncertainty by less than 10 percent. Word-of-mouth is a much more efficient learning channel for consumers, reducing their uncertainty by more than 90 percent. I also find that around 27 percent of advertising spending for movies in my sample is used for signaling product quality, while 73 percent is used for reaching consumers. Studios tendency to advertise more during the pre-release rather than the post-release weeks is explained to a large extent by the signaling purpose.