Working Paper: CEPR ID: DP5152
Authors: Ivan Pastine; Tuvana Pastine
Abstract: This paper studies advertising in vertically differentiated product markets with positive consumption externalities. In markets with consumption externalities, the value of the product to the consumer depends on the purchasing decisions of other consumers. In such markets, we show that firms will engage in advertising competition in order to convince consumers of their popularity only as long as they produce goods of similar quality. The firm with the lower quality product will have a greater incentive to advertise. If it is not the brand to provide the greater consumption externality it will have very low market share due to its low intrinsic quality. Hence, in equilibrium, the lower quality product will often be more popular. This provides an additional explanation for the empirical observation that in some markets high quality is associated with lower levels of advertising.
Keywords: advertising; consumption externalities; coordination; product quality
JEL Codes: L13; L15; M37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Advertising (M38) | Increased consumer interest in lower quality products (L15) |
| Lower product quality (L15) | Greater incentive to advertise (M37) |
| Lower quality product (L15) | More popular in equilibrium (D59) |
| Advertising (M38) | Coordination of consumer expectations (D16) |
| Quality difference significant (L15) | Advertising ineffective for coordinating (P11) |