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The IUP Journal of Applied Economics :
Price Discrimination and Targeted Advertising: A Welfare Analysis
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This paper presents a monopolistic model of price discrimination by means of targeted informative advertising. Targeting is defined as the ability of the firm to direct messages with different contents to different segments of consumers. Segmentation is based on different valuations of the firm's product. The monopolist chooses the level of advertising for each segment of consumers and discriminates price accordingly. The paper shows that when targeting is imperfect the monopolist will over advertise to the highest valuation group of consumers to the detriment of the lowest valuation group. Only when targeting is perfect will the seller behave in a socially desirable manner.

The welfare properties of advertising have been the subject of an ongoing debate that goes back to Kaldor's (1940) classical paper. The strand of industrial organization literature that followed, helped to clarify several concepts such as those pertaining to the distinction between informative and persuasive advertising. The seminal paper of Butters (1977), represented the first successful attempt at modeling the impact of informative advertising in a context where all involved agents act in an optimal fashion. He formally showed that in a monopolistically competitive structure, if informative advertising was the sole source of information, and advertisements (ads, for short) were provided in a purely random fashion to homogeneous consumers, then firms would select a socially optimal level of advertising. This puzzling result was confirmed by Stahl (1994) who extended it to oligopolistic markets and more general advertising technologies. Variations of Butters' (1977) model such as introduction of product differentiation (Grossman and Shapiro, 1984), or heterogeneity among buyers (Stegeman, 1990) were shown to easily offset this result and helped establish the idea that increased competition stimulated additional advertising (the `business stealing effect'), while the inability of the firm to appropriate the social surplus it generates, acts as a deterrent to advertising (Tirole, 1988). Thus, we may opine that with heterogeneous buyers a monopolist will have an incentive to underprovide informative advertising.

Nowadays, it is more realistic to admit that firms have an increasing ability to convey their messages to particular market segments. Indeed, as e-commerce retailing grows and information technologies advance, firms become increasingly able to provide specific ads and prices to different types of customers. Price discrimination by means of targeted advertising becomes a possibility and the welfare implications of this new setting is not clear. Research on targeted advertising and price discrimination is therefore of particular importance. Although recently some theoretical work has been done on the role of targeting as a mechanism that can improve the reach of the firm (Hernandez-Garcia, 1997; Roy, 2000; Esteban et al., 2001; and Iyer et al., 2005), as far as our knowledge is concerned there is no analytical research on targeted advertising and price discrimination.

 
 
 

Price Discrimination and Targeted Advertising, Welfare Analysis, monopolistic model, industrial organization literature, informative and persuasive advertising, homogeneous consumers, oligopolistic markets, information technologies, monopoly market, monopolists strategy.