Modest Advertising Signals Strength
Oakland University - Department of Economics
Per Baltzer Overgaard
University of Aarhus - Department of Economics
Tel Aviv University - Faculty of Management; SUNY at Stony Brook University, College of Arts and Science, Department of Economics
RAND Journal of Economics, Vol. 33, No. 2
We reexamine the role of prices and advertising expenditures as signals of quality. Consumers are either "fastidious" or "indifferent". Fastidious individuals value high quality more and low quality less than do indifferent individuals. Then a sensible and robust separating equilibrium exists in which both types set their full-information prices. However, the high-quality firm cuts advertising 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 favorably to advertising cuts and correctly identify quality. Hence, modest advertising may signal high quality.
Accepted Paper Series
Date posted: August 23, 2002
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