Review of Industrial Organization 21: 89–101, 2002.
© 2002 Kluwer Academic Publishers. Printed in the Netherlands.
Advertising, Its Determinants, and Market Structure
Graduate School of Management, KAIST (Korea Advanced Institute of Science and Technology),
207-43 Cheongryangri, Dongdaemun, Seoul, 130-868, Korea
Abstract. This study derives a formal model of ﬁrm advertising behavior and applies it to the
industry level to ﬁgure out the relationship between advertising and market structure. The ﬁrm
advertising model shows that both consumer preference and ﬁrm-speciﬁc advertising competence
jointly determine proﬁt-maximizing advertising intensity. At the industry level, advertising intensity
is represented multiplicatively by consumer preference and a measure of market structure, which
reﬂects the joint distribution of the levels of advertising competence and market shares among ﬁrms.
The new market structure measure suggests that those single-dimensional measures of market struc-
ture such as seller concentration and the Herﬁndahl index are inadequate in explaining interindustry
differences in advertising intensity, and that the long-debated advertising-concentration relationship
differs depending primarily on the appropriability of advertising. An empirical analysis of 426 ﬁve-
digit Korean manufacturing industries shows that an inverted U-shaped relationship between the
Herﬁndahl index and industry advertising intensity is observed for consumer goods industries but a
lazy J-shaped relationship for producer goods industries.
Key words: Advertising competence, consumer preference, Dorfman–Steiner theorem, inverted U
hypothesis, market concentration.
The relationship between advertising and market structure has long been a sub-
ject of considerable debate during the last three decades. However, as Leahy
(1997) argues, the relationship is far from resolved. The dominant approach to
the study of the relationship has been to empirically test the relationship between
the advertising-to-sales ratio and a measure of market structure such as seller con-
centration and the Herﬁndahl index (e.g., Greer, 1971; Cable, 1972; Sutton, 1974;
Strickland and Weiss, 1976; Martin, 1979; Buxton et al., 1984; Willis and Rogers,
The conventional wisdom, based on conjectures about oligopolistic mutual
interdependence or on the appropriability of advertising, is represented by the
so-called inverted U hypothesis, which implies that moderately concentrated in-
dustries engage more intensively in advertising than both atomistically competitive
The author thanks two anonymous referees and Prof. William G. Shepherd for their valuable
comments on the early versions of this paper.