Consumption externalities, coordination, and advertising

Abstract

The aim of this article is to demonstrate that advertising can have an important function in markets with consumption externalities apart from its persuasive and informative roles. We show that advertising may function as a device to coordinate consumer expectations of the purchasing decisions of other consumers in markets with consumption externalities. The implications of advertising as a coordinating device are examined in the pricing and advertising decisions of firms interacting strategically. Although, at times, the one-period advertising expense can exceed the one-period monopoly profit, in equilibrium, consumers will pay a premium for the more heavily advertised brand.