Lecture 9 - Economics Of Advertising

Question 1

What is advertising a major determinant for

Answer 1

Organic growth and consequently the success of a company

Question 2

What’s advertising useful for

Answer 2

Distinguishing between different types of goods

Question 3

What’s a search good

Answer 3

A product or service with features and characteristics easily evaluated before purchase

Question 4

What’s an experience good

Answer 4

A product or service where product characteristics, such as quality or price, are difficult to observe in advance

• These characteristics can be found out upon consumption

Question 5

What are credence goods

Answer 5

Difficult or impossible to evaluate even after consumption has occurred

Question 6

Whats the purpose of advertising

Answer 6

• Provide consumers with factual information about product attributes.
• Advertising that informs consumers about product specifications benefits society both stimulating the exchange of products to new customers by facilitating better matches between existing customers and brands

Question 7

What 2 things does advertising need to do

Answer 7

• Informative role
• Persuasive intent

Question 8

What’s the informative intent of advertising

Answer 8

• Contains information on product availability, characteristics, quality and price
• Can turn experience or even credence goods into search goods
• However, firms do not wish to simply provide information, but the customers need it

Question 9

What’s the persuasive intent of advertising

Answer 9

• Persuade the customer to buy and own the product
• Hammer into the heads of people the unquestioned desirability, indeed the imperative necessity, of owning the newest product that comes on the market
• This is not possible with search goods

Question 10

What can advertising provide in terms of power

Answer 10

• Advertising can give firms monopoly power
• Can provide a barrier to entry
• Advertising costs can be prohibitive for a new entrant

Question 11

What should Advertising focus on when advertising a product

Answer 11

Focus on the product differentiation

Can be differentiated in terms of:
- Technical standards
- Quality standards
- Design characteristics
- Service characteristics

This can effect competition by reducing it

Question 12

What does Johnson and Myatt (2006) suggest about advertising and demand

Answer 12

Persuasive and informative advertising results in a simple outward shift of the demand curve thus increasing prices

Question 13

Advertising and price elasticities

Answer 13

• This approach suggests advertising levels changes the price elasticity of demand
• A lower price elasticity leads to more market power
• Even without additional concentration in an industry, making markets less competitive

Question 14

Advertising and market concentration approach

Answer 14

• Level of Advertising in a market place is determined by the level of market concentration
• Suggests An inverted U-shaped relationship exists between advertising and market concentration
• As markets become more concentrated there are incentives to advertise to create barriers to entry
• However, There’s a point where if there’s higher levels of concentration, spending on advertising starts to decrease

Question 15

Advertising and competition

1) Product differentiation

Why do firms use advertising to show their product is different

Answer 15

• Established firms use advertising to differentiate their product, suggesting greater quality, better features etc. This can have an anti-competitive effect
• Leading to higher prices possibly
• However implies advertising can allow new firms to establish their name
• Allowing them to gain market share, increasing competition

Question 16

Advertising and competition

2) Increased market concentration

Why do firms advertise when market concentration increases

Answer 16

• Markets with high barriers to entry advertising can result in dominance of the market by a few firms with successful advertising campaigns
• Market concentration increases as a result because some firms become larger while others lose market share

Question 17

Advertising and competition

3) Advertising as a barrier to entry

Answer 17

• In some markets, advertising creates a substantial barrier to entry for new products. E.g. games consoles

Question 18

Three hypotheses of the relationship between advertising intensity, market structure and profit margins

Answer 18

1) High levels of advertising cause and sustain high entry barriers and seller concentration, which leads to higher than average profits

2) High levels of advertising intensity are a consequence, not cause, of market structural imperfection

3) Differences in advertising intensity are not correlated with market imperfections or profit levels, but are explained by other factors, such as the nature of the product or buyer characteristics

Devine et al (1985) find limited evidence of (1), some for (2), but considerable evidence for (3)

Question 19

Ethics and advertising

Answer 19

• Advertising May be a source of market failure if campaigns mislead consumers
• Persuasive intent of advertising may be seen as unethical. E.g. McDonald’s branding to children
• in the UK, Advertising Standards Authority (ASA) acts as an independent regulator of advertising across all media