Modern Industrial Organization Global Edition Solution Manual – 2025 Step-by-Step Market Structure & Strategy Solutions

Chapter 14 g


Advertising and Disclosure
g g




Thegmaterialgongadvertisinggisgimportant:gyougcangremindgstudentsgthatgsomegveryglargegcompaniesgspend
gmoregthangonegfifthgofgtheirgannualgsalegreceiptsgingadvertisementgofgvariousgkinds.gMostgofgthegstudents
ghavegalreadygnotedgthatgstandardgmodelsgofgcompetitiongdognotgtakegintogaccountgthisgimportantgactivity.
gIfgyougaregnotggoinggtogcovergthegentiregchapter,gyougmaygwantgtogusegthegbasicgmaterialgongadvertisingg
whengdiscussinggproductgdifferentiationg(Chapterg7)gandgstrategicgbehaviorg(Chapterg11).

Atgagminimum,gwegrecommendgpresentinggthisgbasicgmaterialgongadvertising.gItgincludesgagdiscussiongofgt
hegtwogtypesgofgadvertising,gandgofgthegoptimalitygrule:gagfirmgshouldgadvertisegtogthegpointgwheregitsgma
rginalgbenefitgequalsgitsgmarginalgcost.gThisgresultgisgderivedggraphicallygandgingagtechnicalgappendix,gwh
ichgisgnotgverygdifficultgandgcouldgbegusedgwithgundergraduatesgwhoghavegsomegknowledgegofgcalculus.g
Thegappendixgdiffersgfromgthegusualgpresentationgingitsgchoicegofgoutputgrathergthangpricegasgthegothergco
ntrolgvariablegbesidesgadvertising.gBygmakinggthisgswitch,gthegoptimizationgconditionsgresemblegthegusual
gconditionsgthatgaregcoveredgingthegearliergchaptersgongmarketgstructure.gItgalsogmakesgthegpresentationgsli
ghtlygeasier.
Studentsgmaygremarkgongthegdifficultygofgassessinggthegbenefitsgofgadvertising,gsogyougcangusegthisgasgagli
nkgtogdiscussgempiricalgevidence.
Itgisgparticularlygimportantgtogstressgtwogdistinctionsgmadegingthegtext.gThegfirstgonegisgbetweengthegsear
chgandgexperiencegqualitiesgofgvariousggoods.gThegsecond,gcloselygrelated,gdefinesgtwogkindsgofgadvertis
ing:ginformativegandgpersuasive.gItgshouldgnotgbegsurprisinggthatgwelfaregresultsgwithgregardsgtoginforma
tivegadvertisinggaregstraightforwardgandgrelategdirectlygtogresultsgofgthegprecedinggchaptergonginformatio
n.gThegimpactgandgdesirabilitygofgpersuasivegadvertisinggaregmuchghardergtogassess.gIfgsomegeconomistsg
concedegthatgsuchgmessagesgmayghelpgcreategspuriousgproductgdifferentiationgandgbarriersgtogentry,gthey
gareggenerallygloathgtogentergintogargumentsgthatgunderminegthegideagofgconsumergsovereignty.


ThegmaterialgongthegDixit-
Normangresultgisgparticularlygcontroversial.gFollowinggthisgdebategisglikegtryingg togplaygcatchgwithgJello.
gNonetheless,gstudentsgnormallygenjoygit.gStudentsgalmostgalwaysghavegstronglygheldgopinionsgongthisgto
pic.gWegusuallygaskgtwogstudentsgtogdebategthegmaterialgwithgcontributionsgfromgthegrestgofgthegclass.

Onegcangskipgthegmaterialgongdisclosure.gThisgmaterial,ghowever,gisgpopulargwithgstudentsgbecausegthegba
sicgresultgisginitiallygcounter-
intuitivegtogmostgofgthem.gItgisgaggoodgideagtogstressgthatgthegstrongestgresultsgheregdependgongstronggassu
mptionsgthatgprobablygdognotgholdgingmostgmarkets.gThegdisclosuregmaterialgmakesgagnicegcomplementgto
gthegdiscussiongofgfalsegorgmisleadinggadvertising.

, Chapterg14g g AdvertisinggandgDisclosure 53



■ AdditionalgExample
SearchgEnginegResultsgAdvertising?

Ing2003,gLouisgVuittongSAgfiledgsuitgagainstgGooglegforgtrademarkginfringement.gVuitton,gmakergofgluxurygl
uggage,ghandbags,gshoes,gandgothergitems,gsuggestsgGoogle’sgsearchgenginegresultsgviolategitsgrights.
SearchgenginesgprovideglinksgtogsitesgrelatedgtogthegkeygwordsgongphrasesgenteredgbygangInternetgsearchg
user.gHowever,gGooglegprovidesglinksgtogcompaniesgandgorganizationsgthatgpaygtogbegassociatedgwithgspe
cificgsearchgkeywords.gGoogleghasgpostedglinksgtogcompanygsitesgevengwhengthegkeywordsgenteredgaregag
trademarkgheldgbyganothergfirm.gIngagsimilargcasegagainstgGoogle,gtwogFrenchgfirmsgweregawardedgdama
gesgofg$89,000.gThegcourtgrulinggstatedgthatgwhengsearchesgaregenteredgongregisteredgtrademarks,gGoogle
g shouldg“findgthegmeansgtogblockgadvertisementsgbygthirdgpartiesgwhoghavegnogrightgtogthesegtrademarks
.”gIfgappliedgbroadly,gthisgwouldgmeangGooglegmaygneedgtoglimitgthegsitesgprovidedgwhengagsearchgoccur
sgongagtrademark,gandgforegogsignificantgadvertisinggrevenuegfromgfirmsgwithoutgtrademarks.

Source:gAssociatedgPress,g“HandbaggMakergVuittongSuesgGoogle,”gwww.cnn.com,gOctoberg24,g2003.


■ AnswersgtogEven-NumberedgProblems
2.
Ifgthegfirmgcangonlygadvertisegoncegingthegfirstgperiod,gitgshouldgadvertiseguntilgthegpresentgva
luegofgthegincreasegingrevenuegresultinggfromgangadditionalgunitgofgadvertisinggequalsgthegcostgofgthat
gunit.gWhengcalculatinggthegincreasegingrevenue,gthegentiregperiodgovergwhichgthegadditionalgunitgofg
advertisinggstillgaffectsgsalesgshouldgbegtakengintogaccount.gIfgadvertisinggcangbegrepeatedgovergtime,
gagformalgdynamicganalysisgisgnecessarygtogcalculategthegoptimalgrategofgadvertisinggatgeachgmoment
gingtime,gtakinggaccountgofgthegrategatgwhichgconsumersgforget.


4. Consumersgwhogboughtgthegmanufacturer’sgproductganywaygmaygbegworsegoffgifgthegpricegofgthegpr
oductgisgraisedgtogpaygforgincreasedglocalgadvertising.gConsumersgwhogwouldgnotghavegbeengawareg
ofgthegproduct,gongthegotherghand,gmaygbegbettergoff.gThegverticalgrestraintsgaregsociallygdesirablegifg
thegadditionalgconsumergsurplusgenjoyedgbygthegsecondgtypegofgconsumersgplusgthegadditionalgprofit
sgofgbothgthegdealersgandgthegmanufacturerg(netgofgthegincreasedgcostgofgadvertising)goutweighgtheglo
ssgingconsumergsurplusgofgthegfirstgtypegofgconsumers.


■ AdditionalgProblems
1. Aregthegfollowinggproductsgprimarilyg(a)gsearchggoodsg(b)gexperienceggoods,gorg(c)gcredenceggoods?
(i) packagegholidays
(ii) insurance
(iii) organicgproduce
(iv) vitamingpills
(v) papergclips

2. Whygdogadvertisementsgforglawgfirmsgfocusgmoregongthegcaregprovidedgtogclientsgrathergthangongt
hegspecificgcharacteristicsgofgtheglawyers?

3. ThegU.S.ggovernmentgandgmanygotherggovernmentsgaidgexportinggindustriesgbygsupplyinggfr
eegadvertisinggabroad.gIsgthisgsociallygdesirable.
(i) fromgagnationalgperspective;
(ii) fromgag“global”gperspective?
Assumegthatggovernmentsgdognotghavegagcostgadvantagegovergexportinggfirmsgingprovidinggadvertisingg
abroad.

,54 Carlton/Perloffg g •g ModerngIndustrialgOrganization,gFourthgEdition,gGlobalgEdition


4. Describegthreegexplanationsgofghowgadvertisinggcangbenefitgconsumers.

5. Whygmightgsomegclaimgadvertisinggforgagparticulargbrandgofgsodium-chloridegsaltgisganticompetitive?

6. Supposegantifraudglawsgingagcertaingcountrygaregstrictlygenforced,gwithgsubstantialgpenaltiesgforglyin
g.gWhatgshouldgagrationalgconsumergingthatgcountrygthengconcludegifgagcerealgpackagegsaysgitg“conta
insgatgleastg5gouncesgofgcereal”?

7. Agmonopolygfacesgtheginversegdemandgcurve,
bQg
pg=gag− ,
g +g1
whereggisgitsglevelgofgitsgadvertising.gItsgmarginalgproductiongcostsgaregconstantgatgm.gShowgingagdi
agramgwhatghappensgtogitsgprice,grevenuesgandgproductiongcostsgifgitgraisesgadvertisinggfromgzerogtog
onegunit.gUndergwhatgconditiongisgadvertisinggbygthegmonopolygprofitable?

8. Agfirmgwithgproductiongcosts

3Q2
C(Q)g=g10g
+ 8
facesgthegdemandgcurve
2

Qg=g36gp g3g,
−2



whereggisgitsglevelgofgadvertising.gOnegunitgofgadvertisinggcostsg$1.gFindgthegfirm’sgoptimalgoutputg
levelgandglevelgofgadvertising.

9. AgfirmgwithgcostsgC(Q)g=g5,000g+g202Qgfacesgtheginversegdemandgcurve
gg g g 
pg=g(400g−gQ)g +g1 ,
 100 
g 
whereggisgitsglevelgofgadvertising.gUsegconsumers’gpre-
advertisinggpreferencesgtogevaluategthegnetgsocialggaingfromgthegfirm’sgfirstgunitgofgadvertising,gif
gthisgunitgcostsg$100.gThengdogthegsamegusinggpost-
advertisinggpreferences.gIsgitgprofitablegforgthegfirmgtogadvertise?

10. Angindustrygconsistsgofgtwogidenticalgfirms,gwithgproductiongcostsgC(qi)g=g200g+g20qig (ig=g1,g2).g
Theginversegmarketgdemandgcurvegis

pg=g100g−gQg+ 1 +g g 2
,
wheregig isgFirmgi’sgadvertisinggexpenditure.gOnegunitgofgadvertisinggcostsg$1.gIfgthegfirmsgplaygCo
urnotgingbothgoutputgandgadvertisingglevels,gwhatgaregthegequilibriumgvaluesgofgbothgvariables?

11. Agfirmgthatgengagesgingadvertisingghasgconstantgmarginalgproductiongcosts.gSupposegdemandgisgweak
lygseparablegingprice,gp,gandgadvertisinggexpenditure,g:
D(p,g)g=gd(p)g(),
Doesgthisgfunctionalgformgsimplifygthegfirm’sgdecisiongaboutgbothgvariables?g(Hint:gdoesgthegfirmgha
vegtogsolvegforgbothgvariablesgsimultaneously?)

, Chapterg14g g AdvertisinggandgDisclosure 55


12. Ingag1950sgsmallgtowngwithgagpopulationgofg24,000gindividuals,gagnewgtechnologyghasgarrived,gbr
oadcastgtelevision,gandgitghasgagconstantgmarginalgcostgofgzero.gAtgthatgtime,gtheregwasgonlygonegs
tationgoperatinggingtown,gandgentrygwasgnotgangimmediategthreat.gTheghourlyginversegdemandgfro
mgadvertisersgforgminutesg(M)gofgairtimegisggivengby
pg=g10g–g5Mg+g0.01A,
wheregAgrepresentsgthegnumbergofgviewers.gIfgeveryonegwatches,gwhatgisgthegprofit-
maximizinggnumbergofgadvertisinggminutesgperghour?gWhatgifgthegstationgownergnoticedgthatgforgev
erygadditionalgminutegofgadvertisements,g400gindividualsgstopgturninggin?gWhatgwouldgbegthegprofit
-maximizinggamountgofgminutesgperghourgingthatgcase?gHowgmanygpeoplegwouldgwatch?