This report studies the relationship between advertising level and product quality where the product is a new non-durable experience good within a signaling game framework. The least cost separating equilibrium of the two period model used in Bagwell (2005) is analyzed without the restriction of advertising being dissipative with repeat business effect. The results are conditionally consistent with Bagwell (2005). Further, advertising level as a signal is assumed to be random variable drawn from Normal and Beta distributions. Consumers update their prior beliefs about the quality of product by Bayes’ distributions. Consumers update their prior beliefs about the quality of product by Bayes’ distributions. Consumers update their prior beliefs about the quality of product by Bayes’ rule after observing the advertising level. We show that pooling equilibria exist with the the the assumption of identical price and marginal costs for high quality and low quality firms. If asymmetric marginal costs are assumed, then the results are consistent with both Nelson (1974) and Schmalensee 1978).
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