“Brand Awareness and Price Competitionin Online Markets” by John MORGAN
University of California, Berkeley
Michael R. BAYE
We study a model where retailers endogenously engage in both brand advertising to attract loyal customers as well as informational advertising, which consists of deciding whether and what price to list on a price comparison site. We derive a symmetric subgame perfect equilibrium of the model and show that endogenous branding does not eliminate equilibrium price dispersion in online markets, although for plausible parameter values, increased branding is associated with lower levels of price dispersion. Price levels are also predicted to depend systematically on firms’ branding activities. These predictions are consistent with online data from a leading price comparison site. An important by-product of endogenizing both brand and price advertising is the asymmetric impact of changes in advertising costs on firm profits. A reduction in the cost of price advertising reduces equilibrium profits whereas a reduction in the cost of brand advertising has no effect on equilibrium profits. Finally, we show that price dispersion persists even when the number of competing firms is arbitrarily large.