Abstract
We study how price advertising of a subset of products affects equilibrium pricing and advertising under two product differentiation regimes. We find that, when firms sell products with the same reservation price, loss-leader pricing obtains only when differentiation is low. However, when reservation prices differ, equilibrium may entail loss-leader pricing even when differentiation is high. This enables us to shed some light on the seemingly paradoxical empirical findings in the marketing literature that loss-leader pricing fails to increase store traffic, loss-leader sales and hence to increase profits. We also examine welfare implications.