A Dynamic Model of Advertising and Product Differentiation

This paper analyses a differential game of duopolisticrivalry through time where firms can use advertisingand price as competitive tools. Two cases are consideredwhereby: (1) advertising has the main effect ofincreasing market size and firms differ in productionefficiency; (2) advertising has both predatory and cooperativeeffects in a symmetric market. The former shows thatmarket shares and advertising shares are positivelycorrelated and that market size increases with thedifference in firms' relative efficiency. The latterhighlights the differences in the feedback andopen-loop strategies. It is shown that firms' advertisingare strategic complements and that profits are higherin the feedback equilibrium because firms advertise more.The applicability of the model in markets wherefranchise contracts and dealership agreements operateis also discussed.