Strategic Implications of Confirmation Bias‐Inducing Advertising

Confirmation bias, a well‐established behavioral anomaly, asserts that when product experience is ambiguous, it is assimilated consistent with expectations set up by prior advertising. In this paper, we combine a strategic model with laboratory experiments to study the effects of consumers’ confirmation bias on firms’ advertising and pricing strategies and its implications for firms’ profits. Our results suggest that confirmation bias does not improve firms’ profits in the short run. However, it confers benefits to products that are frequently purchased in the longer time horizon. We also show that confirmation bias‐inducing advertising can have an inverse relationship with the degree of product differentiation. Furthermore, we show that our results are robust whether confirmation bias is positive or negative, whether consumers have perfect memory or suffer from memory loss, and whether the price premium induced by confirmation bias is fixed or endogenous. Our laboratory experiments test some of these key model predictions. The studies show that individuals behave in a manner consistent with the predictions of our model.