A Mathematical Model for the Origin of Name Brands and Generics

TL;DR

This paper introduces a mathematical model explaining how firms differentiate into name brands and generics based on advertising costs, predicting market segmentation and price distribution patterns validated by consumer data.

Contribution

The paper presents a novel mathematical model linking advertising costs to firm segmentation into brands and generics, supported by empirical data analysis.

Findings

Firms split into high and low advertising groups based on cost-benefit analysis.

Market segmentation into brands and generics is predicted by the model.

Empirical data shows qualitative agreement with the model's predictions.

Abstract

Firms in the U.S. spend over 200 billion dollars each year advertising their products to consumers, around one percent of the country's gross domestic product. It is of great interest to understand how that aggregate expenditure affects prices, market efficiency, and overall welfare. Here, we present a mathematical model for the dynamics of competition through advertising and find a surprising prediction: when advertising is relatively cheap compared to the maximum benefit advertising offers, rational firms split into two groups, one with significantly less advertising (a "generic" group) and one with significantly more advertising (a "name brand" group). Our model predicts that this segmentation will also be reflected in price distributions; we use large consumer data sets to test this prediction and find good qualitative agreement.