Quality Uncertainty and Informative Advertising

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Abstract
We consider a single period model where a monopolist introduces a product of uncertain quality. Before pricing and informative advertising decisions take place, the producer observes the true quality of the good while consumers receive an independent signal which is correlated with the true quality of the product. We show that if informative advertising occurs in equilibrium, there must exist some pooling. Further, we prove that for an advertising full pooling equilibrium to exist, (a) consumers' valuation for the high quality, advertising cost and consumers' prior probability of high quality must be sufficiently high and (b) informativeness of the market signal must be sufficiently low. Existence of an advertising semi-separating equilibrium requires similar conditions. When informative advertising appears in equilibrium, the adverse selection problem is partially mitigated.

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