Econ 165 20. Advertising

Econ 165 20. Advertising - Advertising Advertising is an...

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1 Advertising Advertising is an important choice variable of firms Some ads are informative. For example, many ads of local retailers provide information about prices, store locations, products in stock, etc. Most ads are persuasive rather than informative, and the ads of major manufacturers are almost all persuasive We do not know exactly how persuasive advertising affects the consumer’s decision to buy, but evidence shows that it clearly has an effect Many observers view persuasive ads as wasteful and harmful, but standard economic welfare analysis cannot be done if advertising affects the utility function
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2 The Extent of Advertising In 2002, U.S. firms spent $237 billion on advertising (approximately 2.3% of GDP; the percentage has remained roughly 2% since the 1940s) Roughly 58% is media advertising: TV, radio, magazines, newspapers, yellow pages, the Internet The other 42% includes direct mailings, promotions, coupons, catalogs and other publications, and sponsorships of special events At the firm level or product level, higher advertising is generally associated with higher sales, but advertising to sales ratios (which measure advertising intensity) vary widely, even for similar products within the same industry At the industry level, advertising to sales ratios tend to persist over time
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3 Welfare Effects Advertising that provides relative price information tends to lower the market price Consumers who must search to find the lowest price may choose to pay higher prices instead of bearing the search costs Informative advertising about price allows consumers to find the low price firms without bearing high search costs Most economists consider informative advertising to be welfare improving, and it may be under-supplied if the advertising firm does not appropriate all of the social benefits from the information For example, some consumers might benefit from the information because they decide not to buy the firm’s product (they were looking for “tastes great” not “low calorie”)
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4 The Role of Persuasive Advertising Many economists view persuasive advertising as a socially wasteful way for firms to compete Firms undertake advertising to attempt to persuade consumers that products are special or unique even when there are many close substitutes available The ad-created differentiation provides the firm with market power There is some empirical support for this view: At the retail level, nationally advertised pain relievers, liquid bleach, shampoo, soft drinks, and other products sell for a premium that seems too high to be due to intrinsic differences in product characteristics or production costs
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5 Advertising as Wasteful Competition Consider two or more firms producing similar products Each firm’s advertising has market expansion and business stealing effects If market expansion effect is small and business stealing effects are important, the advertising is essentially social waste; it drives up costs with minimal effects on allocations
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Econ 165 20. Advertising - Advertising Advertising is an...

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