An Empirical Analysis of Dynamic, Nonprice Competition in an Oligopolistic Industry

Abstract

This article develops a dynamic model of nonprice competition in an oligopolistic industry and uses it to analyze advertising competition in the U.S. cigarette industry. The model generalizes existing studies by allowing advertising to affect both firm market shares and the total size of the market. The model also allows dynamic conjectural variations to arise from the intertemporal links created by the durability of advertising. We use these dynamic conjectural variations to distinguish alternative models of competitive interaction. We estimate the complete model of firm production, demand, and advertising choice by using data for U.S. cigarette producers. The results indicate that firm advertising primarily affects the level of market demand, with a firm's effect on rival firms' market shares arising through variations in the number of brands sold. Empirical results on firm behavior suggest that firms act as if their advertising choices will alter the future advertising choices of rival firms in both the high-tar and low-tar cigarette markets.