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Course outline II. Product differentiation Advertising competition Compatibility competition. Heterogeneous goods. Advertising competition I. Advertising and price competition for established products Advertising and price competition for new products

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course outline ii
Course outline II
  • Product differentiation
  • Advertising competition
  • Compatibility competition

Heterogeneous

goods

advertising competition i
Advertising competition I
  • Advertising and price competition for established products
  • Advertising and price competition for new products
  • Sequential advertising competition - entry and deterrence of entry
  • Executive summary
advertising competition ii
Advertising competition II
  • Grossman & Shapiro (1984)
  • Two firms differ with regard to two aspects:
    • Information policy,
    • Horizontal differentiation (model “Hotelling“); here
  • We consider four groups of consumers:
    • Consumers are informed about both goods,
    • Consumers are informed about good 1 only,
    • Consumers are informed about good 2 only,
    • Consumers are not informed about any good.
brand demand with name recognition a 1 and a 2
Brand demand with name recognition A1 and A2

only good 1 is known

both products are known

1

demand for good 1

only good 2 is known

demand for good 2

no good is known

no demand

0

1

h

the demand function
The demand function

Firm 1’s demand function:

Assumption:

price cap!

monopolistic part of demand

price advantage

intensity of competition

demand in case of equal prices

cost of advertising
Cost of advertising

is called the cost rate of advertising.

exercise fixed prices simul taneous vs sequential competition
Exercise (fixed prices, simul-taneous vs. sequential competition)

Consider two insurance companies being forced to sell their policies at a fixed price of 5.

Find the equilibrium name recognitions in a simultaneous advertising competition assuming

Now assume that one company is the advertising leader.

the simultaneous game
The simultaneous game
  • Firm 1’s profit function:
  • Firm 1’s “reaction functions”:

scope for raising prices due to incomplete information

solving the pricing game 2 nd stage
Solving the pricing game (2nd stage)
  • Firms’ reaction functions
  • Bertrand-Nash equilibrium
  • Effect of name recognition on prices:
analyzing the advertising competition 1 st stage
Analyzing the advertising competition (1st stage)

? ? >0 <0 =0

direct

effect

strategic

effect

(optimal prices)

sequential versus simultaneous game
Sequential versus simultaneous game
  • In the simultaneous game, optimal advertising levels are chosen according to :

(the direct effect - the only effect in this case - should be zero)

  • In the sequential game, we found a negative strategic effect of advertising.
  • This yields:
exercise advertising competition
Exercise (advertising competition)

Two tax consultants compete by fixing their level of advertising expenses, A1 and A2. The price of 10 for one consulting hour is given by regulation. Demand and profit functions are given by

Calculate and interpret the reaction functions. Find the equilibria! How will the consultants feel about a law prohibiting advertising?

entry deterrence
Entry deterrence

Follower’s reduced profit function:

=0, optimalprices at 3rd stage

=0, optimal advertising at 2nd stage

executive summary
Executive summary
  • Incomplete information about the products (Ai<1) increases the scope for raising prices.
  • High advertising costs may have positive effects on firm’s profits.
  • The advertising leader has the opportunity to build up a strategic entry barrier (limit adverti-sing expenditure or limit name recognition).
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