Advertising competition n Grossman & Shapiro (1984) n Two firms differ with regard to two aspects: – Information policy – Horizontal differentiation (model “Hotelling“) n We consider four groups of consumers: – Consumers are informed about both goods. – Consumers are informed only about good 1. – Consumers are informed only about good 2. – Consumers are not informed about any good.

Brand demand with name recognition f 1 and f no demand demand for good 1 demand for good 2 both products are known only good 1 is known only good 2 is known no good is known

The demand function Firm 1‘s demand function: intensity of competition monopolistic part of demand price advantage

How does the price elasticity depend on name recognition? Special case:

Cost of advertising is called the cost rate of advertising.

Advertising and price competition for established products

The simultaneous game n Firm 1‘s profit function: n Firm 1‘s “reaction functions”: scope for raising prices due to incomplete information

Symmetric equilibrium Equilibrium:

Exercise (name recognition) How do the name recognitions depend on the cost rate in the equilibrium of the simultaneous advertising and price competition,

Advertising and price competition for new products

Solving the pricing game (second stage) with price cap n Firms‘ reaction functions n Bertrand-Nash equilibrium n Effect of name recognition on prices:

Analyzing the advertising competition (first stage) ??>0<0=0 directstrategic(optimal effecteffect prices)

Sequential vs. simultaneous game n In the simultaneous game, optimal advertising levels are chosen according to: n In the sequential game, we found a negative strategic effect of advertising. n This yields:

Advertising and price competition with advertising leader

Entry deterrence Follower‘s profit function: direct effect (<0) strategic effect (<0) optimal prices (=0) optimal name recognition (=0)

Exercise (simultaneous 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 Now assume that one company is the advertising leader. Calculate the equilibrium name recognitions.

Exercise (advertising competition) Two tax consultants compete by fixing their level of advertising expenses, A 1 and A 2. The price of 10 for one consulting hour is given by regulation. Demand and profits functions are given by Calculate and interpret the reaction functions. Find the equilibria. Are both of them stable? What are the profits in the equilibria? (Assume 0/0=1.) How will the consultants feel about a law prohibiting advertising?