Welcome back to week 10 of the Power of Markets course. In this session, we'll keep looking at the effects of imperfect information. We'll look in particular at how much dispersion of prices will there be across sellers of the same product. How will the cost of searching across different sellers by buyers affect the price dispersion? And then we'll also look at advertising. Does it create market power, or does it lessen market power? First, let's look at the price dispersion. Now, one can predict that there'll be less price dispersion for products that have a higher price tag. Why? Because everything else equal, buyers are more likely to gauge and search when it comes to an automobile that costs $30,000, as supposed to an item that may cost, a stick of gum, that may cost only five cents. So the variance in prices is likely to be smaller, everything else equal for higher priced products. But then we also have to look at search costs. How much time and effort does it take for consumers to determine a particular product, both its quality and its price? And so when you think about searching for pizza, let's say, in your local college market, and there are 20 different providers of pizza, how many phone calls will you be willing to make? Will you call all 20 shops, or will you call only three or four, and after three or four, get a sense of what the pattern is and pricing? For a typical consumer, we expect him or her to compare the extra effort it takes to call yet another pizza parlor versus the prospective gain in finding a lower priced supplier of that pizza that we're looking for. So, the greater the search intensity, we expect greater search intensity of higher priced products, as a result, we expect less price dispersion. Now let's look at advertising. There's a long history in economics, deposits, what advertising does is it creates potentially a barrier to entry. It serves to differentiate a product versus competing products. And there's a competing view also in economics that advertising provides information that's valuable as supposed to artificial. Let's look at those two views in figure 14.1, and let's assume initially that if the firm's demand curve is D1, where no firms are advertising, the blue-colored demand curve. If just this firm engages in advertising, it can create more differentiated product even if that differentiation is artificial. The demand curve becomes less elastic through advertising. But it's not just this firm that can advertise. So if we allow for competition across firms in a market, the opposing view that advertising provides information lowers price dispersion ends up arguing that we'll end up with the D3 demand curve, an overall more elastic demand where customers are more responsive to the price charged by this individual firm. Which view is correct? Is advertising artificially creating a barrier to entry, or does it serve to provide information? There's been a long literature in economics investigating this view. And from the 1950s through the 1990s, there hasn't been a strong consensus whether advertising can be correlated with greater barriers to entry and greater profitability. If anything, advertising seems to provide more of a positive informational view based on this literature than a barrier to entry. Now, when we look at advertising, we also have to look at the full price of a product in marketing efficiency. And what we mean by the full price you pay is not just the price of the product, but the price the consumer pays to search for that product. To an economist, we have to be conscious looking at a market that the full price the consumer pays when we deal with imperfect information. The advertising this information view strives to lower the full price consumers pay. The advertising this product differentiation view has a deleterious effect, creates more of a barrier to entry even if there is no valuable information provided, but just from this opposing view creates a greater market inefficiency. The consensus of the economic studies if anything leans more toward advertising is promoting market efficiency. But admittedly, it has been a very long and significant debate in the economics literature on precisely this issue. In the next few sessions, we'll turn to some applications of imperfect competition on Monopoly Theory. We'll look forward to having you back then.
