Advertising, Entry Deterrence, and Industry Innovation

Shi Qi ()
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Shi Qi: Department of Economics, University of Minnesota

No 2008-1, Working Papers from University of Minnesota, Department of Economics

Abstract: This paper studies how advertising influences firms’ incentives to invest in R&D. The link between advertising and industry innovation is important, not only because advertising can spur R&D by spreading product knowledge, but also because advertising can discourage new innovative firms from entering the industry. This paper finds that a worse advertising technology can result in local improvements in industry innovation rates. Globally, however, a complete ban on advertising always reduce industry growth. This result is significant because industry advertising spending is quantitatively significant and there are potential connections between public policy towards advertising and R&D. This paper presents a variant of the Grossman and Helpman (1991) quality ladder model. The key difference is that the model in this paper allows advertising to gradually spread product awareness among consumers. This model differs from the entry deterrence literature by assuming perfect price discrimination. Technically, this assumption allows a fully tractable model and analytical characterization of a stationary equilibrium in a dynamic setting, which is not previously available. In terms of economic analysis, this assumption eliminates the extra profit incentives for new firms to enter early, and makes incumbent firms more inclined to use advertising as a deterrent.

Keywords: Advertising; Entry Deterrence; Innovation (search for similar items in EconPapers)
JEL-codes: L15 L25 M37 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2008-24-03, Revised 2008
New Economics Papers: this item is included in nep-ino, nep-mkt and nep-tid
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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