Modest Advertising Signals Strength.

Abstract

This paper presents a signaling model where both price and advertising expenditures are used as signals of the initially unobservable quality of a newly introduced experience good. Consumers can be either "fastidious" or "indifferent". Fastidious individuals place a greater value on a high-quality product and a lesser value on the low-quality product than do indifferent individuals. It is shown that a sensible separating equilibrium exists where both firms set their full information prices. However, the high-quality firm cuts advertising expenditures below the full information level of the low-quality firm, even if the full information advertising expenditures of the high-quality firm are larger than those of the low-quality firm. Consumers respond positively to advertising cuts and correctly identify the product quality. Hence, modest advertising may signal high quality.product quality; informative advertising; signaling; signal reversal