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Informative Price Advertising in a Sequential Search Model

Jacques Robert
Dale O. Stahl II

Abstract

The purpose of this paper is to study the role and implications of price advertising when shopping trips are costly to consumers. To do so, we introduce advertising into an optimal sequential search model. Information about prices is both gathered by consumers and disseminated by firms. Consumers search sequentially and stores advertise (with various intensity) when it is in their interest to do so. Our model has a unique equilibrium exhibiting price dispersion. The model generates predictions about the shape of the price distribution and firms' advertising behavior. We explore the effects of entry, and find that when initial advertising costs (at zero level of effort) are precisely zero, entry drives the equilibrium to the perfectly competitive outcome. However, when initial marginal advertising costs are positive, entry drives prices higher, and while the informed consumers almost surely locate competitive prices, welfare does not necessarily increase. Finally, we compare the effectiveness of the two informational channels. When advertising costs shrink, prices become competitive; however, when search costs shrink, prices remain bounded above marginal production costs.