Substitution effect of advertising on resale price maintenance: using a real options approach

Abstract

This article investigates the incentives to impose Resale Price Maintenance (RPM) from the real options perspective, how manufacturers use national advertising as a substitute for RPM when RPM is made illegal. Purchase delay caused by frequent markdowns among retailers encourages the manufacturers to impose RPM. But advertising mitigates the impacts of frequent markdowns by decreasing the demand price elasticity. When RPM is prohibited, we find that manufacturers increase national advertising expenditures to reduce the negative externality of frequent markdowns.

Notes

¹See http://www.oecd.org/daf/ccp.

²Black and Scholes (1973) and Merton (1973) showed how to value a financial option whose payoff is contingent on the value of the underlying asset. Brennan and Schwartz (1985) and McDonald and Siegel (1985) were the first to actually apply these insights to investment valuation, which is now known as real options analysis.