This dissertation, in its most general context, is an investigation into the modeling of markets with imperfectly informed agents. In such markets, there will invariably be incentives for informed agents to take advantage of information asymmetries by disseminating the relevant information to uninformed agents. Similarly, there will be incentives for uniformed agents to reduce the adverse effects of information asymmetries by acquiring the relevant information. The primary purpose of this dissertation is to demonstrate that the understanding of such markets can be greatly enhanced by explicit modeling both channels of information flow as omitting either channel could eliminate important interaction effects. The arguments in this dissertation are narrowly framed within a familiar differentiated market in which firms advertise and each consumer is imperfectly informed about which product is most suited to his taste. However, the conclusions drawn in the dissertation are applicable to more general economic systems in which it is costly for agents to acquire information relevant to the decision-making process. There is a long-standing debate in the literature about whether or not advertising is purely informative. Although there is extensive research on advertising models and consumer search models, little is known about differentiated markets in which firms advertise and consumers search. In modeling advertising and consumer search, this dissertation questions the relevance of two pieces of evidence that have been offered against the view that advertising is informative. In the first instance, I demonstrate that firms may use purely informative advertising and still maintain market power in the long-run in monopolistically competitive markets; this finding thus rejects the argument that firms rely on manipulating consumer preferences in order to maintain market power in these markets. In the second instance, I demonstrate that advertisements without any information about the product being advertised may still be informative to some consumers; this finding thus rejects the argument that the widespread use of uninformative television advertisements is inconsistent with the view that advertising is informative in nature. This dissertation shows that our understanding of the nature of advertising (information dissemination mechanism) is greatly enhanced by modeling consumer search (information acquisition mechanism).

Due to the important role of advertising in marketing practice, its effects have been the research focus since 1920. Among relevant research fields, the issue that has been paid close attention in the economic field is its impact on consumer welfare. Issues focused in the marketing field are its impacts on consumer perception, feelings, attitudes, behaviors, and competitive interaction among firms. However, in these two fields the integrated channel is the focused scenario where the advertising works in vast majority of literatures. Only very few of them investigate effects of advertising in other channel structure context. However, in practice indirect channels are very common. There may be interactions between advertising and channel structure due to the existence of the independent retailer and the specific degree of competition. Since advertising is an important strategic instrument, it deserves to pay more efforts to relate the advertising and channel structure. This dissertation use game-theoretical approach to target three issues relating the advertising and channel structure. The first issue focuses on discussing the differential of choices between informative and persuasive advertising across three channel structure contexts for two competing manufacturers. This dissertation argues that the use of advertising strategy crucially depends on the channel structure. Specifically, it shows that when manufacturers delegate the sales responsibility to dedicated retailers, informative advertising may yield a higher profit for the manufacturers due to its pro-competitive nature. On the contrary, persuasive advertising should be used more extensively when either the manufacturers sell directly to the end consumers or sell through a common retailer. This therefore provides a theoretical foundation for why both advertising strategies can emerge as optimal responses from the manufacturers' viewpoints and subsequently provides handy guidelines for when these advertising strategies should be used in various scenarios. The second issue is about the choice between direct and indirect channels. The introduction of independent retailers has long been recognized as a buffer that alleviates the price competition between channels. If the sales responsibility is delegated to the retailers, the retail prices are driven upwards, thereby allowing the manufacturers to avoid the head-to-head competition. In this dissertation, we argue that this effect may be counter-balanced if the manufacturers are privileged with sufficiently large loyal segments. It shows that, selling directly to the consumers (through the direct channel) may be more beneficial for the manufacturers than delegation with the presence of competition, because the low prices due to the intense competition may help the manufacturers to extract more revenue from loyal consumers. Furthermore, if the manufacturers compete along dimensions that differ from prices, they may be further in favor of the direct channel and less concerned about price competition. In particular, this dissertation shows that if the manufacturers also compete on their advertising strategies, delegating to the retailers may force them to invest on the wasteful advertising, which could be prevented had the manufacturers sold the products themselves. The third issue discusses the combativeness of the persuasive advertising in the common retailer channel. The existing marketing literature suggests that persuasive advertising elicits counteractions from competing manufacturers and consequently leads to wasteful cancellation of the advertising effects. However, recent empirical studies document a surprisingly negative result against this conventional wisdom. To provide a theoretical ground for this empirical puzzle, we propose a novel way to model the advertising effect on the consumers' preference that incorporates two critical driving forces: on one hand, advertising shifts the consumers' preferences towards the advertised product (the "absolute effect"); on the other hand, it also makes the rival product a less desirable substitute from the consumers' viewpoints (the "relative effect"). Through our alternative interpretation of persuasive advertising, we show that channel conflict can be alleviated if a manufacturer adopts persuasive advertising that wisely "targets" appropriate consumers. In stark contrast with the established work, this advertising strategy may give rise to profit increases for every channel member, including the rival manufacturer and the retailer that were previously believed to always counteract/ resist to such persuasive advertising. We further identify the detailed operating regimes within which such a manufacturer-initiated persuasive advertising strategy is no more harmful for other channel members.

There are two main views of advertising – the informative view and the persuasive view. This thesis studies aspects of the informative view. One aspect of interest is whether firms can benefit from collusion on advertising even though advertising is only informative. If so, will this enhance or lower welfare? There are several reasons why firms may want to collude on adver­tising. First, the legal field is tilted in favour of nonprice collusion. Second, it is not at all obvious that collusion on price is more profitable than collusion on advertising and third, the analyses of Grossman and Shapiro (1984) and others show that profits can be increased by restricting advertising. In Paper 1, we examine firms’ incentives to collude on advertising and the implications for welfare. We find that collusion on advertising and competition on price is more profitable than competition on both price and advertising. We also find that semicollusion on advertising is detrimental to welfare. This suggests a need for monitoring, especially since it is in the interest of firms to restrict price advertising. We also compare semicollusion on price to semicollusion on advertising. We find that, in general, semicollusion on price does not lead to higher profits compared to semicollusion on advertising. Hence we lend theoretical support to the empirical literature that consistently find evidence of semicollusion on advertising rather than on price. Another important issue concerns the effect, on prices and profits, of ad-vertising only a subset of the product range. Many firms, in particular those in the retail sector, sell a wide variety of products but only advertise a few. Recent empirical evidence suggests that prices of unadvertised products are higher (Milyo and Waldfogel, 1999). Theoretically, little is known. In Paper 2, we study the effects of advertising only a subset of products. We allow for both low and high differentiation and, at the same time, we explicitly model the advertising decision. We find that the extend of differentiation between competing firms plays an important role in the analysis of loss leader pricing. When firms sell products with the same reservation price, loss leader pric­ing obtains only when differentiation is low. When products are less similar however, price competition is less intense and, as a result, firms advertise prices above marginal cost. Our loss leader pricing results enable us to shed some light on the seemingly paradoxical empirical findings in the marketing literature that loss leader pricing fails to increase store traffic, loss leader sales and hence to increase profits. We also consider a different subject – price discrimination. Although it is well understood that movements in the exchange rate have a bearing on firm profitability and hence affect firm behaviour, the role of exchange rate variability in the firm’s choice of the number of varieties to produce has (to my knowledge) not been explored. This, despite the fact that the product mix is an important aspect of firm strategy. By tinkering with the number of varieties, a firm can bolster its ability to extract consumer surplus. In Paper 3, we explore this issue. We show that variability in the exchange rate induces the firm to vertically segment markets (i.e., offer two varieties in each market). This happens because exchange rate variability affects income dispersion and hence the firm’s incentives to extract consumer surplus. To better extract surplus, the firm offers two price-quality menus, high quality variant (priced high) for top-end surplus extraction and a low quality variety (priced low) to address market coverage concerns. / <p>Diss. Stockholm : Handelshögskolan, 2005 S. 3-9: sammanfattning, s. 13-95: 3 uppsatser</p>