On the competitive effect of informative advertising

Abstract

This paper analyses the competitive effects of informative advertising. The seminal work by Grossman and Shapiro (1984) show that informative advertising results in lower prices and that firms may benefit from advertising restrictions. A crucial assumption in their model is that captive (partially informed) consumers are not price responsive. Replicating their model in a Hotelling duopoly version, we show that results are in fact reversed if we allow for captive consumers to respond to prices. We then use general demand functions and derive exact conditions for the competitive effect to prevail. A main result is that the procompetitive effect depends on the nature of competition and the relative price elasticities of the monopoly and the competitive demand segments.