Persuasive Advertising and Market Competition

Abstract

This paper studies a duopoly industry where the firms compete for market shares by choosing output prices and advertising outlays. Advertising is purported here to be persuasive rather than informative as it is described in most signaling models. Persuasive advertising tends to cancel each other out and this leads us to question the possibility of firms reducing advertising outlays collusively. Using output cost to stand proxy for output quality, it is found that a robust positive association exists between output cost (quality), output price and advertising activity. We should therefore expect a firm producing higher output quality to advertise more and charge higher price than its lower quality rival even when neither advertising nor price is used as an information dissipating signal. Advertising is also found to be a credible tool to facilitate collusive commitment.