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SAMF-Fagkomiteen for samfunnsvitenskap

Advertising and Competition in Markets with Network Externalities

Awarded: NOK 1.8 mill.

In many markets a consumer's benefit from choosing a product is higher the larger the share of the product's adopters. This is known as network externalities. With network externalities, even if many consumers believe an alternative product is inherently better, these consumers will not adopt the alternative product unless they expect a sufficiently large share of other people to also adopt this product. Thus, the market can be locked-in on the particular product currently dominating the market, even if t his product is inferior to alternatives. The literature on network externalities has identified beliefs about future market shares as the crucial factor as to whether the market will be locked in on an inferior product. In the proposed project we will theoretically and empirically investigate how advertising can affect the formation of such beliefs and possibly break a lock-in. Our investigation of how advertising affect beliefs in markets with network externalities will be based on the phenomena of ' availability heuristic' by Tversky and Kahneman. The availability heuristic says that people infer the prevalence of an event 'from the ease with which the event can be recalled or imagined'. This suggests that firms can influence people's perception of market shares by making them more familiar with their product thorugh exposing people to their products in advertisements. So far economic theories of advertising has emphasized how the incumbent can use advertising as entry deterrence. This literature has been criticized for lacking an understanding of how advertising affect behavior. We avoid this problem by modeling an explicit mechanism through which advertising affects behavior. We hypothesize that this model will show that advertising can break a lock-in if the entry product is of sufficiently higher quality than the incumbent product. This is contrary to previous economic models of advertising and has important implication for anti trust policy.

Funding scheme:

SAMF-Fagkomiteen for samfunnsvitenskap

Thematic Areas and Topics

No thematic area or topic related to the project