Product Characteristics and Price Advertising with Consumer Search

Abstract

Many advertisements inform the consumer about product characteristics, while others give price information with very little product information, and some provide both types of information. We propose a framework to analyze the incentives for firms to provide various types of information. We consider the case of a single seller. There is no incentive to provide information on product characteristics only, since doing so leads to a holdup problem that the consumers would rationally expect the firm to charge such a high price that no consumer would wish to incur the prior search cost. (A more general argument applies to markets with several firms.) However, price-only and price-and-characteristics advertising can arise depending on the relative strength of product differentiation and consumer search costs. Even when it costs the firm very little to inform consumers the firm may have no incentive to advertise if consumers will sample it anyway. For low search costs the firm has a strict incentive NOT to let consumers know because the firm garners higher profit when consumers have sunk the search cost. Forced disclosure and dissemination of information improves social welfare by eliminating useless search behavior that leads to no purchases (as well as enabling consumers to buy at lower prices). Second, even when the firm must advertise to bring in consumers (i.e., for larger search costs), the firm may prefer to keep consumers in the dark about how much they like the product - this behavior again entails excessive search. Finally, even when the firm finds it optimal to inform consumers of both their match values and the price charged, the level of advertising is too small because the firm only accounts for its private benefit per consumer informed when determining how much to advertise, and not the extra benefit to consumers of making a valuable match.