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Industrial Economics Lecture 7.pptx

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Industrial Economics Lecture 7.pptx

  1. 1. Lecture Seven Advertisement The Nature and Roles of Advertising  The term ‘‘advertising’’ is expenditure undertaken by a firm to promote the sales of its products or services.  The most visible form of advertising is paid-for space in print, radio or television media.  Advertising also includes promotional activity for a product, such as special displays, offers in shops or at commercial shows.  Economists distinguish two roles of advertising.
  2. 2.  The first: is the provision of factual information to consumers about the characteristics of a product, its price and its availability.  Such advertising helps consumers overcome information deficiencies.  The second: is the persuasion of consumers to buy a particular product or visit a particular shop or restaurant, by emphasizing the qualities of the product or associating the product with a particular life style or celebrity.  Such advertising is sometimes comparative in nature, with one producer comparing its product with those of others, with the intention of making the advertised firm’s product look superior.
  3. 3.  The implicit assumption: is that informative advertising is good for the consumer, while persuasive advertising is not; though in practice it may be hard to distinguish between the two. Firms engage in advertising for a number of reasons  First, they try to change consumer preferences by persuading consumers of the superior quality of their product by providing information about it and by promoting brand loyalty. • As a consequence, the firm promotes extra sales or is able to sell its product at a higher price.  In addition, the firm may be able to lower average costs of production by producing and selling more output, thereby increasing profits. Advertising is designed to alter the consumer’s preferences in favor of advertised products and against non-advertised products.
  4. 4.  Advertising is often the principal method employed by firms to increase perceived differences between products among consumers and to create brand loyalty.  Therefore, it is a major competitive tool, especially when used in combination with other competitive weapons, such as price reduction.  In some oligopolistic markets, variations in advertising expenditure are thought to be more important than lowering price in trying to sell more of a product.
  5. 5. • Advertising is undertaken to stimulate demand and, thereby, lower the price elasticity of demand for the product.  If consumers are persuaded to buy more of a good at every price, so that the demand curve shifts outward to the right, then consumers will buy more at the current price; but, the price elasticity of demand on a linear demand curve will have fallen.  Alternatively, the firm can charge a higher price for the same level of output.  Another motive for advertising is to lower average production costs as a consequence of selling more output.
  6. 6.  A firm with a short-run, U-shaped cost curve will face lower costs if it sells more, providing it is operating on the downward-sloping segment of the average cost curve.  If the firm is also on the downward portion of its long-run average cost curve, then significant increases in sales could lead to larger production facilities being constructed and further falls in average production costs.  Advertising is also an expense, and the average unit expenditure on advertising may more than offset the reductions in production costs achieved by selling more.
  7. 7.  The relationship between sales and advertising expenditure can be expressed as a ratio.  The average ratio would be measured by S/A, where S is total sales revenue and A is total advertising expenditure.  The marginal relationship between sales and advertising expenditure is given by S/A.  Baumol, in his sales maximization model, assumed that the marginal-sales-to-advertising ratio was always positive and greater than 1.
  8. 8.  This assumption means that all advertising campaigns are successful.  In practice, advertising campaigns can be unsuccessful; this is indicated in two ways:  first, a positive advertising-to-sales ratio of less than 1 would indicate that sales revenue had increased by less than the increase in advertising expenditure; and,  second, a negative sales-to-advertising ratio would indicate that an increase in advertising expenditure had led to a decline in sales.
  9. 9.  It is expected that advertising initially generates a S/A ratio of substantially greater than 1, but that the ratio declines with successive increments in spending.  The declining responsiveness of demand to a change in advertising expenditure may be linked to: The life cycle of the product and its falling growth rate as consumers satiated with the product, cease buying for the first time and buy only for replacement reasons. The perceived requirement of competitors to spend heavily on advertising to maintain or increase their market share in a declining market, because of the unwillingness of consumers as a result of brand loyalty to switch from one brand to another.
  10. 10. 1.2 Effectiveness of Advertising as a Market Weapon  Many theorists believe there to be chain reactions of advertising effects which arise from learning and attitude-change through the purchase and repurchase stages to the final impact on a firm’s sales and profits.  For this let us consider the basic functions advertising performs in marketing a product to a consumer.  Familiarise: making a product well known to the consumer. This minimises the fear of the unknown, by reducing uncertainty.  Reminding: re-announcing the brand’s intrinsic values to consumers who already use it.
  11. 11.  Spreading news: this is the stereotyped role of advertising, announcing new products, changes in the existing product, price reductions and new sizes or colours.  Overcoming inertia: for example, exercises where the rewards are remote and the costs are immediate. Advertising can provide a simulated experience of the reward, on the same principles as a virtual reality computer game.  Adding a value not in the product: it may be argued that advertising creates genuine and real values that are, nevertheless, purely subjective. This is not surprisingly the most controversial function of advertising. The persuasiveness of messages is difficult if not impossible to quantify. This creates a difference of opinion as to whether advertisement is informative or persuasive.  The next section tries to explain three views about advertisement.
  12. 12.  Is Advertising Informative or Persuasive? • Three views of advertising emerged in the economics literature. These are the persuasive view, the informative view and the complementary view.  The Persuasive View • The persuasive view holds that advertising primarily affects demand by changing tastes and creating brand loyalty. • The advertised product thus faces a less elastic demand. • This elasticity effect suggests that advertising causes higher prices, though this influence may be moderated by the presence of production scale economies. • The persuasive view holds further that advertising may deter entry.
  13. 13.  Consumers are reluctant to try new products of unknown quality, and this experience- based asymmetry between established and new products may be exacerbated in the presence of heavy advertising by established firms.  Advertising may be particularly effective in this regard if there are scale economies in advertising or production.
  14. 14. The Informative View  The informative view holds that advertising primarily affects demand by conveying information.  The advertised product thus faces a more elastic demand.  This elasticity effect suggests that advertising causes lower prices, an influence which is reinforced when production scale economies are present.  The informative view suggests further that advertised products are generally of high quality, so that even seemingly uninformative advertising may provide the indirect information that the quality of the advertised product is high.
  15. 15.  There are three reasons.  First, the demand expansion that advertising induces is most attractive to efficient (low-cost) firms, and such firms are likewise attracted to demand expansion achieved by offering low prices and high-quality products.  Second, the product experience memories that advertising renews are most valuable to firms with high-quality products, since repeat purchases are then more likely.  Third, a firm sensibly targets its advertising toward consumers who would value its product most.  The informative view holds further that advertising is not used by established firms to deter entry; instead, advertising facilitates entry, since it is an important means through which entrants provide price and quality information to consumers.
  16. 16. The Complementary View • Finally, the complementary view holds that advertising primarily affects demand by exerting a complementary influence in the consumer’s utility function with the consumption of the advertised product. • As an example, it may be that a consumer values “social prestige”, and advertising may then serve as an input that enables the consumer to derive more social prestige when the advertised product is consumed. • The complementary view is logically distinct from the persuasive view, since the complementary view:  holds that consumers possess a stable set of preferences into which advertising enters as one argument.  advertising may affect consumer demand even if it contains no (direct or indirect) information.
  17. 17.  An important benefit of the complementary view is that the fixed-preferences assumption permits a straightforward welfare analysis of seemingly persuasive (or at least uninformative) advertisements.  Under this view, the market may provide too little advertising, since the advertising firm does not internalize the full increase in consumer surplus that its advertising engenders.
  18. 18. Optimal Level of Advertising or Measuring Advertising Intensity  In imperfectly competitive markets, competition between firms is based on using a combination of advertising, price and product characteristics.  If the firm can adjust both price and advertising expenditure, then the firm is able to use a combination of both to compete with its rivals.  To maximize profits a firm will equate marginal revenue to marginal cost whether it advertises or not.  The optimal level of advertising expenditure for the firm is determined where the marginal increase in costs of advertising is equal to the marginal increase in revenue.
  19. 19.  The practicability of this rule requires the assumption that the firm will know with certainty the nature of the cost and revenue functions required to determine the optimal level of advertising.  In practice, however, this is rarely possible due to the lack of detailed disaggregated data and the cost of obtaining such information.  In addition, the firm in the models outlined is able to reach decisions without taking into account the possible reactions of its rivals.
  20. 20.  Advertising expenditure may have an impact on consumer preferences and sales in more than one period.  Some consumers may react instantly to the message of the campaign; others may react more slowly and may only remember the advertising content when they consider purchasing the product sometime in the future.  For example, infrequently purchased items may only be replaced when they cease working or fashions change.  Few households replace fireplaces or baths frequently, but when they come to do so they may remember the advertisement.  Advertising in one period, therefore, can have an impact on sales in future periods because advertising builds continued awareness of the product or firm among consumers.  By capturing the delayed response on the part of consumers from each campaign, a cumulative effect on sales may be observed.
  21. 21.  The conditions for optimal advertising outlined earlier were based on the assumption that all effects occurred in one time period.  Clearly, the greater the impact of advertising within one period the more relevant will the analysis be.  But, the greater the impact of the advertising in subsequent periods the less relevant will the analysis be.  Giving consideration to future impacts would justify higher levels of advertising in the initial period than the single period analysis might suggest.
  22. 22. Advertising and Market Structure  One of the factors determining the level of a firm’s advertising expenditure is the size and number of competitors in the market.  If the firm sells a homogeneous product in a perfectly competitive market, then advertising would appear to be unnecessary.  However, if consumers are not perfectly informed, then industry-wide advertising would make sense to overcome this deficiency.  At the other extreme, a monopolist would likewise hardly need to advertise because consumers would have no other source of the product.  In practice, a monopolist may advertise to encourage consumers to buy more of its products in particular, rather than on other products in general.
  23. 23. • Therefore, the market structures in which advertising might be expected to be a significant competitive weapon will be those ranging from monopolistic competition to duopoly where products are differentiated and there are relatively few competitors. • In monopolistically competitive markets, products are differentiated; this means that, although there is large number of competitors, each firm’s product is not a perfect substitute for the products of other suppliers. • The demand for each firm’s product tends to be more price-inelastic than in more competitive markets and the advertising-to-sales ratio would be higher.
  24. 24.  In oligopolistic markets with differentiated products, similar considerations apply.  Therefore, the expectation is that advertising- to-sales ratios will be low in uncompetitive markets and monopoly, but higher in imperfectly competitive markets where products are differentiated. • This relationship is illustrated in Figure 6 .1, where market concentration is measured on the horizontal axis and the advertising-to-sales ratio on the vertical axis.
  25. 25. Figure 6.1: Advertising and Market Structure
  26. 26.  If a firm gains an increased market share in a rapidly expanding market by advertising, then it will experience growth.  It will also gain market power and be expected to have a higher price–cost margin.  Thus, larger firms will have higher profit rates than smaller firms.  Having achieved higher profits through increasing its advertising-to-sales ratio, the firm may continue to increase its ratio because it makes life difficult for its less successful rivals to maintain their position.  High advertising-to-sales ratios, which are difficult for smaller rivals to match, may also deter potential entrants to the market; this creates a barrier to entry against potential entrants.
  27. 27. • Thank you for your attention @ being an economist in all your journey!!!

Notas do Editor

  • loyalty to brand of goods: the tendency to buy a particular brand of a product
  • Stereotype -label

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