Research Note: Additional Learning and Implications on the Role of Informative Advertising

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. It is rather to show that increases in informative advertising alone can lead to both higher or lower prices. I further show that the direction of this relationship depends on the level of differentiation between competing firms. Similar to Grossman and Shapiro (1984), I examine conditions where the differences between competing products are small, but I also examine conditions where the differences are significant. The role of advertising is to inform consumers about individual products and higher advertising for a product means that more of the potential market knows about it. Higher levels of advertising increase the relative importance of fully informed consumers compared to partially informed consumers. This dynamic is the basis for explaining why informative advertising can push prices either up or down in a uniformly distributed spatial market.