DP5152 Coordination in Markets with Consumption Externalities: The Role of Advertising and Product Quality

Author(s): Tuvana Pastine, Ivan Pastine
Publication Date: July 2005
Keyword(s): advertising, consumption externalities, coordination, product quality
JEL(s): L13, L15, M37
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5152

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.