Frisch Centre



 

Advertising as Distortion of Learning in Markets with Network Externalities

By Brekke, Kjell Arne and Mari Rege
Memorandum 24/2006

Abstract We present a theory of how advertising can break a lock-in by distorting beliefs about market shares in markets with network externalities. On the background of the availability heuristic we assume that people learn about market shares by observing product adoption of others, but are not able to fully distinguish between observations of real people and ?ctitious characters in advertisements. We look at a game between an incumbent and an entrant producing close substitutes. Our analysis shows that if the entrant?s product is of su¢ ciently high quality, then the entrant will use advertising in order to break the lock-in and the incumbent will not advertise at all. However, if the quality di¤erential between the two products is small, then the incumbent may advertise and make it unpro?table for the entrant to break the lock-in.
JEL Classification: D21, L10, M37
Keywords: Advertising, availability heuristic, herding behavior, information, lock-in
Project: 8101 Advertising and Competition in Markets with Network Externalities
   
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