Solution Manual for Modern Industrial Organization, Global Edition | Complete Answers & Explanations

Chapter 14 j


Advertising and Disclosure
j j




Thejmaterialjonjadvertisingjisjimportant:jyoujcanjremindjstudentsjthatjsomejveryjlargejcompaniesjspendjmor
ejthanjonejfifthjofjtheirjannualjsalejreceiptsjinjadvertisementjofjvariousjkinds.jMostjofjthejstudentsjhavejalrea
dyjnotedjthatjstandardjmodelsjofjcompetitionjdojnotjtakejintojaccountjthisjimportantjactivity.jIfjyoujarejnotjgo
ingjtojcoverjthejentirejchapter,jyoujmayjwantjtojusejthejbasicjmaterialjonjadvertisingjwhenjdiscussingjproduct
jdifferentiationj(Chapterj7)jandjstrategicjbehaviorj(Chapterj11).


Atjajminimum,jwejrecommendjpresentingjthisjbasicjmaterialjonjadvertising.jItjincludesjajdiscussionjofjthejtw
ojtypesjofjadvertising,jandjofjthejoptimalityjrule:jajfirmjshouldjadvertisejtojthejpointjwherejitsjmarginaljbenefi
tjequalsjitsjmarginaljcost.jThisjresultjisjderivedjgraphicallyjandjinjajtechnicaljappendix,jwhichjisjnotjveryjdiffi
cultjandjcouldjbejusedjwithjundergraduatesjwhojhavejsomejknowledgejofjcalculus.jThejappendixjdiffersjfrom
jthejusualjpresentationjinjitsjchoicejofjoutputjratherjthanjpricejasjthejotherjcontroljvariablejbesidesjadvertising
.jByjmakingjthisjswitch,jthejoptimizationjconditionsjresemblejthejusualjconditionsjthatjarejcoveredjinjthejearl
ierjchaptersjonjmarketjstructure.jItjalsojmakesjthejpresentationjslightlyjeasier.
Studentsjmayjremarkjonjthejdifficultyjofjassessingjthejbenefitsjofjadvertising,jsojyoujcanjusejthisjasjajlinkjtojd
iscussjempiricaljevidence.
Itjisjparticularlyjimportantjtojstressjtwojdistinctionsjmadejinjthejtext.jThejfirstjonejisjbetweenjthejsearchjandj
experiencejqualitiesjofjvariousjgoods.jThejsecond,jcloselyjrelated,jdefinesjtwojkindsjofjadvertising:jinforma
tivejandjpersuasive.jItjshouldjnotjbejsurprisingjthatjwelfarejresultsjwithjregardsjtojinformativejadvertisingjar
ejstraightforwardjandjrelatejdirectlyjtojresultsjofjthejprecedingjchapterjonjinformation.jThejimpactjandjdesir
abilityjofjpersuasivejadvertisingjarejmuchjharderjtojassess.jIfjsomejeconomistsjconcedejthatjsuchjmessagesj
mayjhelpjcreatejspuriousjproductjdifferentiationjandjbarriersjtojentry,jtheyjarejgenerallyjloathjtojenterjintoja
rgumentsjthatjunderminejthejideajofjconsumerjsovereignty.

ThejmaterialjonjthejDixit-
Normanjresultjisjparticularlyjcontroversial.jFollowingjthisjdebatejisjlikejtryingj tojplayjcatchjwithjJello.jNone
theless,jstudentsjnormallyjenjoyjit.jStudentsjalmostjalwaysjhavejstronglyjheldjopinionsjonjthisjtopic.jWejusu
allyjaskjtwojstudentsjtojdebatejthejmaterialjwithjcontributionsjfromjthejrestjofjthejclass.

Onejcanjskipjthejmaterialjonjdisclosure.jThisjmaterial,jhowever,jisjpopularjwithjstudentsjbecausejthejbasicjres
ultjisjinitiallyjcounter-
intuitivejtojmostjofjthem.jItjisjajgoodjideajtojstressjthatjthejstrongestjresultsjherejdependjonjstrongjassumption
sjthatjprobablyjdojnotjholdjinjmostjmarkets.jThejdisclosurejmaterialjmakesjajnicejcomplementjtojthejdiscussi
onjofjfalsejorjmisleadingjadvertising.

, Chapterj14j j AdvertisingjandjDisclosure 53



■ AdditionaljExample
SearchjEnginejResultsjAdvertising?

Inj2003,jLouisjVuittonjSAjfiledjsuitjagainstjGooglejforjtrademarkjinfringement.jVuitton,jmakerjofjluxuryjluggag
e,jhandbags,jshoes,jandjotherjitems,jsuggestsjGoogle’sjsearchjenginejresultsjviolatejitsjrights.
SearchjenginesjprovidejlinksjtojsitesjrelatedjtojthejkeyjwordsjonjphrasesjenteredjbyjanjInternetjsearchj user.jH
owever,jGooglejprovidesjlinksjtojcompaniesjandjorganizationsjthatjpayjtojbejassociatedjwithjspecificjsearchj
keywords.jGooglejhasjpostedjlinksjtojcompanyjsitesjevenjwhenjthejkeywordsjenteredjarejajtrademarkjheldjby
janotherjfirm.jInjajsimilarjcasejagainstjGoogle,jtwojFrenchjfirmsjwerejawardedjdamagesjofj$89,000.jThejcour
tjrulingjstatedjthatjwhenjsearchesjarejenteredjonjregisteredjtrademarks,jGooglej shouldj“findjthejmeansjtojblo
ckjadvertisementsjbyjthirdjpartiesjwhojhavejnojrightjtojthesejtrademarks.”jIfjappliedjbroadly,jthisjwouldjmea
njGooglejmayjneedjtojlimitjthejsitesjprovidedjwhenjajsearchjoccursjonjajtrademark,jandjforegojsignificantjad
vertisingjrevenuejfromjfirmsjwithoutjtrademarks.

Source:jAssociatedjPress,j“HandbagjMakerjVuittonjSuesjGoogle,”jwww.cnn.com,jOctoberj24,j2003.


■ AnswersjtojEven-NumberedjProblems
2.
Ifjthejfirmjcanjonlyjadvertisejoncejinjthejfirstjperiod,jitjshouldjadvertisejuntiljthejpresentjvaluejofj
thejincreasejinjrevenuejresultingjfromjanjadditionaljunitjofjadvertisingjequalsjthejcostjofjthatjunit.jWhenj
calculatingjthejincreasejinjrevenue,jthejentirejperiodjoverjwhichjthejadditionaljunitjofjadvertisingjstilljaff
ectsjsalesjshouldjbejtakenjintojaccount.jIfjadvertisingjcanjbejrepeatedjoverjtime,jajformaljdynamicjanaly
sisjisjnecessaryjtojcalculatejthejoptimaljratejofjadvertisingjatjeachjmomentjinjtime,jtakingjaccountjofjthej
ratejatjwhichjconsumersjforget.

4. Consumersjwhojboughtjthejmanufacturer’sjproductjanywayjmayjbejworsejoffjifjthejpricejofjthejproductj
isjraisedjtojpayjforjincreasedjlocaljadvertising.jConsumersjwhojwouldjnotjhavejbeenjawarej ofjthejprodu
ct,jonjthejotherjhand,jmayjbejbetterjoff.jThejverticaljrestraintsjarejsociallyjdesirablejifjthejadditionaljcons
umerjsurplusjenjoyedjbyjthejsecondjtypejofjconsumersjplusjthejadditionaljprofitsjofjbothjthejdealersjandj
thejmanufacturerj(netjofjthejincreasedjcostjofjadvertising)joutweighjthejlossjinjconsumerjsurplusjofjthejf
irstjtypejofjconsumers.


■ AdditionaljProblems
1. Arejthejfollowingjproductsjprimarilyj(a)jsearchjgoodsj(b)jexperiencejgoods,jorj(c)jcredencejgoods?
(i) packagejholidays
(ii) insurance
(iii) organicjproduce
(iv) vitaminjpills
(v) paperjclips

2. Whyjdojadvertisementsjforjlawjfirmsjfocusjmorejonjthejcarejprovidedjtojclientsjratherjthanjonjthejspe
cificjcharacteristicsjofjthejlawyers?

3. ThejU.S.jgovernmentjandjmanyjotherjgovernmentsjaidjexportingjindustriesjbyjsupplyingjfreejad
vertisingjabroad.jIsjthisjsociallyjdesirable.
(i) fromjajnationaljperspective;
(ii) fromjaj“global”jperspective?
Assumejthatjgovernmentsjdojnotjhavejajcostjadvantagejoverjexportingjfirmsjinjprovidingjadvertisingjabroa
d.

,54 Carlton/Perloffj j •j ModernjIndustrialjOrganization,jFourthjEdition,jGlobaljEdition


4. Describejthreejexplanationsjofjhowjadvertisingjcanjbenefitjconsumers.

5. Whyjmightjsomejclaimjadvertisingjforjajparticularjbrandjofjsodium-chloridejsaltjisjanticompetitive?

6. Supposejantifraudjlawsjinjajcertainjcountryjarejstrictlyjenforced,jwithjsubstantialjpenaltiesjforjlying.jWh
atjshouldjajrationaljconsumerjinjthatjcountryjthenjconcludejifjajcerealjpackagejsaysjitj“containsjatjleastj5j
ouncesjofjcereal”?

7. Ajmonopolyjfacesjthejinversejdemandjcurve,
bQj
pj=jaj− ,
j +j1
wherejjisjitsjleveljofjitsjadvertising.jItsjmarginaljproductionjcostsjarejconstantjatjm.jShowjinjajdiagramj
whatjhappensjtojitsjprice,jrevenuesjandjproductionjcostsjifjitjraisesjadvertisingjfromjzerojtojonejunit.jUn
derjwhatjconditionjisjadvertisingjbyjthejmonopolyjprofitable?

8. Ajfirmjwithjproductionjcosts

3Q2
C(Q)j=j10j+
8
facesjthejdemandjcurve
2

Qj=j36jp j ,
−2 3j



wherejjisjitsjleveljofjadvertising.jOnejunitjofjadvertisingjcostsj$1.jFindjthejfirm’sjoptimaljoutputjlevelja
ndjleveljofjadvertising.

9. AjfirmjwithjcostsjC(Q)j=j5,000j+j202Qjfacesjthejinversejdemandjcurve
jj j j 
pj=j(400j−jQ)j +j1 ,
100 
j 
wherejjisjitsjleveljofjadvertising.jUsejconsumers’jpre-
advertisingjpreferencesjtojevaluatejthejnetjsocialjgainjfromjthejfirm’sjfirstjunitjofjadvertising,jifjthisju
nitjcostsj$100.jThenjdojthejsamejusingjpost-
advertisingjpreferences.jIsjitjprofitablejforjthejfirmjtojadvertise?

10. Anjindustryjconsistsjofjtwojidenticaljfirms,jwithjproductionjcostsjC(qi)j=j200j+j20qij (ij=j1,j2).jThejinv
ersejmarketjdemandjcurvejis

pj=j100j−jQj+ 1 +j j 2j ,

wherejij isjFirmji’sjadvertisingjexpenditure.jOnejunitjofjadvertisingjcostsj$1.jIfjthejfirmsjplayjCournotji
njbothjoutputjandjadvertisingjlevels,jwhatjarejthejequilibriumjvaluesjofjbothjvariables?

11. Ajfirmjthatjengagesjinjadvertisingjhasjconstantjmarginaljproductionjcosts.jSupposejdemandjisjweaklyjse
parablejinjprice,jp,jandjadvertisingjexpenditure,j:
D(p,j)j=jd(p)g(),
Doesjthisjfunctionaljformjsimplifyjthejfirm’sjdecisionjaboutjbothjvariables?j(Hint:jdoesjthejfirmjhavejtoj
solvejforjbothjvariablesjsimultaneously?)

, Chapterj14j j AdvertisingjandjDisclosure 55


12. Injaj1950sjsmalljtownjwithjajpopulationjofj24,000jindividuals,jajnewjtechnologyjhasjarrived,jbroadca
stjtelevision,jandjitjhasjajconstantjmarginaljcostjofjzero.jAtjthatjtime,jtherejwasjonlyjonejstationjopera
tingjinjtown,jandjentryjwasjnotjanjimmediatejthreat.jThejhourlyjinversejdemandjfromjadvertisersjforj
minutesj(M)jofjairtimejisjgivenjby
pj=j10j–j5Mj+j0.01A,
wherejAjrepresentsjthejnumberjofjviewers.jIfjeveryonejwatches,jwhatjisjthejprofit-
maximizingjnumberjofjadvertisingjminutesjperjhour?jWhatjifjthejstationjownerjnoticedjthatjforjeveryjad
ditionaljminutejofjadvertisements,j400jindividualsjstopjturningjin?jWhatjwouldjbejthejprofit-
maximizingjamountjofjminutesjperjhourjinjthatjcase?jHowjmanyjpeoplejwouldjwatch?