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Informative advertising: additional learning and implications (RV of 2001/94/MKT)

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Observers argue that evidence for the persuasive role of advertising comes from competitive categories where increases in advertising lead to higher average prices. Conversely, others claim that advertising serves a purely informational role. Here, higher levels of advertising lead to better-informed consumers and this should increase competition and stimulate lower prices. The objective of this study is to neither confirm nor refute either of these perspectives of advertising. It is rather to show that increases in informative advertising alone can lead to both higher or lower prices. The author further shows that the direction of this relationship depends entirely on the level of differentiation between competing firms. This is done by extending the analysis of Grossman and Shapiro (1984) to conditions where the differences between competing products are more significant. The role of informative advertising is to inform consumers about individual products and higher advertising for a product means that more of the potential market knows about it. As the fraction of consumers informed about available products increases, the focal point of competition between firms changes. Changes in this focal point of competition is the basis for explaining why informative advertising can either push prices up or down in a uniformly distributed spatial market.

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