Lecture 9: More on advertising Tom Holden

Transcription

1 Lecure 9: More on adverising Tom Holden hp://io.holden.org/

2 More on adverising: Models. Welfare. Empirics. Reminder: Addiional reference for he adverising maerial: Bagwell (005)

3 There are a large number of firms, each of which can produce a mos one insance of he same good, for a cos of c. There is no enry cos, bu no one will buy from a firm unless hey receive an adver from hem. Sending an adver o one random consumer coss a. Each adver liss he firm s price. Consumers will buy from any firm ha sends hem an adver wih a price below heir valuaion v. Consumers who receive advers from muliple firms buy from he cheapes.

4 If a firm sends an adver lising a price P, wih some probabiliy X P i will be he cheapes adver ha consumer receives, and hey will make profis of P c. Thus oal expeced profis from sending an adver are P c X P a. Because here are a large number of firms (equivalenly, no enry coss), each firm mus make zero profis. If here was a firm making posiive profis, hen I would wan o send ou advers offering a price jus below he one i had chosen. Bu hen my rival faces a lower probabiliy of selling a his posed price, so mus be making lower profis. Hence: a = P c X P for all P firms se, so X P = a. P c Since X P is a probabiliy he price can never be below he level a which 1 = X P = a, i.e. P a + c. P c Since no one will buy if P > v, no firm will adverise a price above v. Bu since X v = a a > 0 here mus be a probabiliy ha a consumer will v c v c only receive one adver, meaning firms can sill sell a v. Indeed, in equilibrium, here are firms seing a price a every poin beween a + c and v.

5 X P looks a lo like he demand curve faced by each firm. Inuiively hen, we migh expec monopolisiccompeiion syle disorions. In fac, his is efficien (welfare opimal). Price is a ransfer, so i s irrelevan. The social benefi o reaching a new consumer (for sure) is v c. Thus he social benefi from sending anoher adver is v c imes he probabiliy ha he consumer had no received any oher advers. Bu his probabiliy is a, in equilibrium. v c So social benefi o anoher ad equals he cos! However, when consumers have heerogeneous valuaions i may be shown ha adverising is inadequae.

6 Two firms, Hoelling se-up, fixed locaions (0 and 1), linear ranspor cos, zero MC. Firm A (B) sends advers o a proporion z A (z B ). This coss hem r z A ( r z B ). Advers are randomly disribued over consumers so, e.g. a proporion 1 z A 1 z B receive no ads so do no buy. As in he sandard Hoelling model, of hose consumers who received wo ads, he indifferen one is locaed a x = 1 + p B p A. Demand faced by firm A is hen: z A 1 z B + z A z B x.

7 1 So firm A s profis are: z A 1 z B + z B + p B p A p A r z A. FOC z A : 0 = 1 z B + z B 1 I.e. z A = p A r + p B p A 1 1 z B + z B + p B p A. p A rz A. FOC p A : 0 = z A 1 z B + z B 1 + p B p A I.e. p A = 1 1 z z B + z B + p B p A. B z Az B p A. Soluion mus be symmeric, wih p p A = p B and z z A = z B. Hence: z = p 1 z and p = 1 z. r z I.e. pz = rz p. So p = r and z = r p 1+ 1 p r = p r+p = r r+ r = 1+ r For his o be valid we need z < 1. r > is necessary and sufficien for his. Profis hen are: 1+ r r r r 1+ r = r 1+ r. 1+ r r r = r 1+ r

8 So Price is higher han wihou he need for adverising. (r > implies P = r >.) When producs are more differeniaed ( is high), here is more adverising. So even if we observe higher differeniaion in indusries wih a lo of adverising, i does no mean ha adverising caused he differeniaion. Expensive adverising acually increases profis. High coss reduce he amoun of adverising performed, reducing he proporion of consumers who see wo advers, pushing up prices. Adverising cos and differeniaion have he same (posiive) effec on profis, bu opposie effecs on he amoun of adverising performed. Thus we should no be surprised by finding eiher a posiive or a negaive correlaion beween adverising and profis. There may be oo much or oo lile adverising. If exra adverising reaches a new consumer, hen he social benefi exceeds he privae benefi o he firm (non-appropriabiliy). Bu firm A has an incenive o adverise more in order o expand is marke share (business sealing).

9 A model of complemenary adverising will begin wih specificaions for agen s uiliy funcions under which viewing advers (or ohers viewing advers) is a complemen for he good. A very simple model is he following. If I have no seen an adver, hen I value he good a zero. If I have seen an adver, hen I value he good a v. Thus every model of informaive adverising may be reinerpreed as a model of complemenary adverising.

10 Read Bagwell (005)! Conclusion is ha differen views are valid in differen indusries. Consisen wih he informaive/search view. Benham (197) found eyeglass prices were higher where adverising was banned. Kwoka (1984) found a similar resul for opomery. Milyo and Waldfogel (1999) look a he end of a ban on liquor price adverising and find firms cu he prices of only hose goods ha eiher hey adverise or heir rival does. Oher imporan papers: Comanor and Wilson (1967) find profis, adverising and differeniaion move ogeher. (Possible in Grossman and Shapiro (1984) model.) Nelson (1974), Porer (1974), Esposio e al. (1990) produc characerisics are imporan. Experience goods differen o search goods ec. Some evidence for an inverse-u relaionship beween concenraion and adverising (bu e.g. Willis and Rogers (1998) find he opposie resul.)

11 Adverising is no unambiguously bad. All hree views (persuasive, informaive, complemenary) have somehing going for hem. Bu he persuasive view is unpopular hese days for mehodological reasons. Empirical evidence is hard o inerpre, since differeniaion, enry, adverising and profis are all endogenous.

12 OZ Ex Quesion 1, OZ Exra exercises: hp://ozshy.50webs.com/io-exercises.pdf Se #16

13 And a Happy New Year.