Advertising and Consumer Search

Abstract

This dissertation advances our understanding of interaction between advertising and consumer search. If advertising lowers consumer search costs, it can affect competition. Previous studies by Butters (1977) and Robert and Stahl (1993) show that giving sellers the option of price advertising can significantly lower equilibrium market prices. These models assume that sellers make two bundled decisions: sellers determine the proportion of buyers that receive advertisements (ads) and reveal the price that they intend to charge in such ads. However, the vast majority of advertising does not reveal product pricing. Chapter 1 argues that certain types of advertising may reduce consumer search costs without actually mentioning the price in the message. This leads me to propose a model in which firms first decide whether to advertise, and then set prices. In this model, the equilibrium price with advertising returns to the monopoly level.Chapter 2 provides an experimental test of the theoretical model in the previous chapter. In the laboratory sessions, each period human sellers make two decisions: what price to set, and whether to advertise to eliminate consumer search costs for their product. Robot buyers then follow an optimal search rule (known to all sellers) to decide which price offer (if any) to accept. The two experimental conditions are (1) advertising the price, or (2) advertising before pricing. Data from ten sessions indicate that, as predicted, firms choose more often to advertise when advertising conveys price, and prices in the second treatment are significantly higher than prices in the first treatment.Chapter 3 uses patterns of prices for books to investigate the empirical validity of the theoretical predictions that as the consumer search cost for a homogenous good goes up, both the market price and the degree of price dispersion for that good will go up (Butters 1977, Robert and Stahl 1993). Search costs for books sold in retail bookstores are presumably higher than search costs for books sold online. By comparing prices on the internet and prices in retail bookstores for the same book, this study finds that the internet has a negative impact on average prices. This finding is consistent with the theoretical predictions. However, the empirical evidence shows that the internet does not lower the variance of prices. Several possible explanations for this observation are provided.