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ADVERTISING

ADVERTISING. Advertising aims to create subjective image differences and hence product differentiation . Product differentiation is a tool to increase profitability by decreasing the elasticity of demand . Advertising plays a key role in the development of the market strategy.

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ADVERTISING

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  1. ADVERTISING

  2. Advertisingaimstocreatesubjectiveimagedifferencesandhenceproductdifferentiation.Advertisingaimstocreatesubjectiveimagedifferencesandhenceproductdifferentiation. • Productdifferentiation is a tooltoincreaseprofitabilitybydecreasingtheelasticity of demand.

  3. Advertisingplays a key role in thedevelopment of the market strategy • Advertisingallowsfirmstoprovideinformationdirectlytoconsumers. • Ithelpsfirmstocreateorincreasedemandfortheirproducts. • Itallowsfirmstobuild a “brandimage”. • Itallowsfirmstodifferentiatetheirproducts.

  4. Types of Advertising • Wedistinguishbetweeninformalandpersuasiveadveritising. • Informational (orinformative) adveritisng is designedtoprovidetruthfulinformationaboutprice,locationorquality. (Does it?) • Empricialevidencesuggestthatadvertisingaboutprice (priceadvertising) results in lowerprices.

  5. Do youthinkthatadvertisingworks? Does it changeconsumerbehaviour? • As an example: AppleAdvertisingmayhelpmanufacturerstakeadvantage of economies of scale in productionanddistribution.

  6. Advertising is arguedtoimprovequality. Since manufacturersbuild a brandimageviaadvertisingtheytrytoliveuptothisimageandincreasethequality of production. • Advertisingmay be seen as a commitment. • Inreal life wealwaysfaceimperfectinformation. Informativeadvertisingincreases market demand as moreconsumersbecomeaware of theproduct. • Informativeadvertisingallowsfirmstoincreasedemand but at thesame time demandbecomesmoreelastic. (Why?)

  7. PersuasiveAdvertising • Intherealworldadvertising is morepersuasiveratherthaninformational. • Themainfocus of advertising is tobuildbrandloyalty. • Persuasiveadvertising is designedtoinfluenceconsumertastesover a particularproduct. • Persuasiveadvertisingcreates/increases market powerbecause it is designedtopersuadeconsumersthatthere is no/littlesubstituestotheirproducts. • Moreover, brandloyalty is an importanttoolfor an incumbentfirmto set-upentrybarriers.

  8. Informativeadvertisingdecreases market power/prices/profits. • Persuasiveadvertisingincreases market power/prices/profits. • So in a socialwelfaremannerpersuasiveadvertisingdecreasessocialwelfarewhereasinformativeadvertisingincreases it. (Really?)

  9. Cost of advertising (2009 US data-millions of dollars)

  10. AdvertisingandQuality • Phillip Nelson (1970,1974) developed a model on advertising. • Considertwoproducers of toothpaste. BothtoothpastescontainfluorideandhavetheAnericanDentalAssociationseal of approval. But thehigh-qualitytoothpastetasteswonderfulandthelowqualitytoothpastetasteshorrible. Thecosts of productionareassumedto be equal. • Who has a higherincentivetoadvertise?

  11. Largeadvertisingexpendituresbyhigh-qualitytoothpastemanufacturersignalconsumersthat it produces a highqualityproduct. Becauseonlyhigh-qualityproducersadvertiseextensively. (Do youagree?)

  12. WelfareEffects of Advertising • Doesadvertisingincreaseordecreasewelfare? • Dixit-Norman model. • Theyanalysedthewelfareeffects of advertising in monopoly, oligopolyandmonopolisticcompetition. Theirconclusionswerethesameforallmarkets. Wewillonlyconsiderthemonopoly model.

  13. From a socialwelfareperspective, allmonopolistsspendtoomuch on advertising. DixitandNormanshowedthatthisresultalsoholdsforoligopolyandmonopolisticcompetition. • Inthis model advertisingassumedto be purelypersuasive, therefore had no socialvalue. • Somecriticisethe model arguingthatinformativeadvertisingwouldhavepositiveimpact on socialwelfare. (Do youagree?)

  14. Anotherargument is thatadvertisingmaypositivelyinfluenceconsumer’sutilitybymakingthemaware of theproduct. (Do youagree?)

  15. Dorfman-Steiner Model • This model is alsoconstructedformonopoly. • Inthe model, onlyquantitiy is a function of advertising. Price is independent of advertising.

  16. D-S conditionstatesthattheproportion of revenue a firmwillspend on advertising is determinedbytheratio of advertisingelasticitytopriceelasticity. • A monopolistwillkeepspending on advertisinguntilthepoint it setsadvertisingtosalesratioequaltotheratio of theadvertising-to-priceelasticity. • Since this is a monopoly model, market power is highandpriceelasticty is lowsoadvertisingexpenditureswill be high.

  17. Inthe D-S model profitability is linkedtoadvertisingexpentiditures. • Thequestion is: Does a monopolistreallyneedsadvertising?

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