Advertising and Cost Reduction

The empirical literature on internalization has found a positive relationship between advertising intensity and foreign direct investment. The model presented in this paper explains this evidence by a technological change in the communications environment and makes predictions for other cost-reducing investments. We consider a market in which a single producer launches a new product. At first potential buyers are unaware of the product and its price, and the producer decides the optimal advertising strategy. We find that both advertising spending and investment in per unit cost reduction are higher under targeting than under mass advertising when the advertising technology exhibits marginal economies of targeting.