Book Description
We study a scenario in which firms offering products of different qualities can use persuasive advertising to influence consumers' preferences and perceptions about product quality. Consumers have an absolute and a relative component of utility from quality, and derive diminishing marginal utility of quality (e.g., due to loss aversion from qualities below a reference point). We consider two types of effects of ads: influencing a consumer's valuation of quality relative to price (valuation shifting), and influencing a consumer's reference point against which she evaluates quality (reference shifting). We find that a monopolist only uses ads that increase total utility from a product. However, competing firms may use ads that reduce total utility from a product - even their own product (e.g., by making the quality reference point higher) - because they may increase the utility of their offering in comparison with the competing offering, thus placing them in a favorable competitive position. We also find that the faster the marginal utility from quality diminishes, the greater preference firms have for reference-shifting ads over valuation-shifting ads. Interestingly, perceived consumer surplus may decrease if products are less differentiated, even though this leads to higher pricing competition, because of shifts in advertising strategy.
