Product Variety, Informative Advertising, and Price Competition

Abstract

In many product categories, consumer tastes are diverse, and firms use finely targeted advertising to inform consumers about their products. This article proposes a model of informative advertising that allows for diverse consumer tastes and multiple competing firms. Using this framework, the authors analyze how diversity in consumers’ tastes, informative advertising, and improvements in advertising technology may influence prices. First, informative advertising can lead to lower prices if consumer valuations are high. However, if consumer valuations are low, informative advertising can lead to higher prices. Second, when consumer valuations are high, price increases with greater diversity in tastes, though this result reverses if consumer valuations are low. Third, improvements in advertising technology lead to higher levels of advertising when consumer valuation is high, but the opposite effect can occur when consumer valuation is low. The authors relate these theoretical findings to previous empirical literature on advertising.