We study how price advertising of a subset of products aspects equilibrium pricing and advertising under low and high product differentiation. We find that, when firms sell products with the same reservation price, loss-leader pricing obtains only when differentiation is low. However, when reservation prices differ, equilibrium may entail loss-leader pricing when differentiation is high. This enables us to shed some light on the seemingly paradoxical empirical findings in the marketing literature that loss-leader pricing fails to increase store traffic, loss-leader sales and hence to increase profits.
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