Expanding Demand through Price Advertisement

Abstract

Price advertisement by retail stores is pervasive. If there exist non-negligible costs of consumer search, a retailer can increase the number of consumers visiting its location by advertising a low price, thus increasing consumers' expected utilities from search. If the increase in the number of consumers who visit the store is substantial, then the store's profit goes up even though low prices decrease profit margins. We show that this intuition extends to the case of a multi-product monopolist, who may choose to advertise very low prices for a limited number of items it carries, even when advertised and non-advertised commodities are substitutes. Finally, we analyze a retail duopoly in which both stores sell from the same location, showing that under some circumstances, there is an incentive for one of the retailers to free-ride on the other's advertisement.