3.4.
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Introduction
• Advertising is a strategy used by producers to
communicate information to consumers about the
goods or services they have to sell.
• Advertising is perhaps the most widely used method
for informing or persuading consumers of the benefits
of choosing a particular goods or services
• Advertisement can involve a number of practices
including direct mail, in-store promotion,
telemarketing, product placements, sponsorship and
exhibitions.
• Expenditure on advertisement is expenditure which is
increased by the seller with a view to increasing sales
of the commodity.
• Advertisement cost is different from production cost
and transferring the commodity to the consumer costs
• Producers often use advertising to persuade
consumers that there are genuine differences between
competing brands of a product or service.
• Over longer periods of time, advertising can be used
to construct an attractive image for a brand, and
strengthen the loyalties of the brand’s consumers.
• In different countries there is regulation of
advertising, firms often made outrageous claims in
promoting their products.
• Production and information technologies have given
firms more flexible systems to deliver goods, services
and advertising messages to consumers.
• Advertising is one of the main weapons of
competition between firms.
• In the oligopoly market case firms prefer to avoid
price competition, and instead engage in non-price
forms of competition such as advertising or research
and development etc.
• Some economists have argued that advertising leads
to a misallocation of resources, because advertising
distorts consumer preferences.
• Others believe advertising improves the flow of
information concerning product and service
attributes, and therefore improves the allocation of
resources.
• Thus informative advertisement is good and
persuading advertisement is not
Types of Advertisement
• Many economists draw a distinction between
informative and persuasive advertising.
Informative advertising
• Informative advertising provides consumers with
factual information about the existence of a product,
service or brand, or about attributes such as its price,
features or uses.
• Informative advertising aims to give consumers
information with which to make informed choices
Persuasive advertising
• Persuasive advertising makes claims which may not
be objectively verifiable, aiming to change
consumers’ perceptions of a product, service or brand
with a view to stimulating sales.
• Example:
– Driving a sporty car will help you become rich,
glamorous or powerful;
– Wearing a certain brand of trainers will turn you
into a world champion.
• Economists often take a positive view of informative
advertising, and a more critical view of persuasive
advertising.
• Informative advertising is ‘good’ because reliable
information is a powerful lubricant, needed to ensure
the smooth functioning of competitive markets.
• But persuasive advertising is ‘bad’ because it
(perhaps deliberately) sets out to mislead or confuse,
and may even tend to distort competition.
• In practice, however, it is often difficult to make a
clear distinction between informative and persuasive
advertising.
• Many advertisements seek to inform and persuade at
the same time.
• Some advertising messages (informative) provide
useful information about the attributes of the
products, services or brands they promote, enabling
consumers to make more informed choices.
• However, advertising which seeks to persuade
consumers of the superiority of particular goods by
transmitting messages whose truth (or otherwise) may
be unreliable, or at least not objectively verifiable,
may represent a waste of resources or may damage
competition or reduce welfare.
Why firms Advertise?
• In general, advertising seeks to either inform or
persuade or do both.
• However, there are specific reasons why firms invest
in advertising campaigns:
i. To launch a product or service. Advertising can be
used to provide potential consumers with
information concerning a new product or service.
Such advertising may be primarily informative
rather than persuasive.
ii. To provide information on price , quality, location
• Advertising can be used to provide consumers with
information concerning price and quality attributes of
products and services.
• This is particularly important if these attributes tend
to change rapidly over time, as a result of competition
or technological change.
• Advertising may be used to provide consumers with
information on the location of the firm’s sales outlets.
iii. To increase or protect market share.
• Advertising campaigns may be designed to persuade
consumers that a firm’s products and services are
superior to those of its competitors.
• In a rapidly expanding market, there may be less need
for advertising of this kind, as there is a large pool of
potential customers available for all firms.
• Where consumer demand is stagnant or decreasing,
firms may tend to advertise more heavily, in an effort
to protect their individual shares of a dwindling
market.
iv. To establish a brand’s image or strengthen
consumers’ brand loyalties.
• Advertising can be considered as a type of investment
expenditure, whereby a firm seeks to create positive
associations in consumers’ minds with its own brand,
which may yield benefits to the firm in the form of
lasting consumer brand loyalty.
• Goodwill and positive reputation effects can act as
significant entry barriers, making it difficult for
outside firms to establish a presence in a market
dominated by an established brand that has been
heavily advertised in the past.
v. Change in the marginal cost of advertising.
Decrease in government taxation of advertisement
increases advertisement
Advertising and Product Characteristics
• Several economists have suggested that product
characteristics may be an important determinant of
advertising intensity.
• Assessable goods: Goods whose attributes consumers
can assess accurately before they are purchased and
consumed are unlikely to be the subject of large-scale
advertising campaigns.
Example: Phone specification
• Non-assessable goods: Goods whose attributes are
difficult to assess may be more heavily advertised.
Example: food
• Products may also be classified into search goods,
experience goods, and credence goods
• Search goods: Search goods are those whose
attributes can easily be determined by inspection,
either by touch or by sight, prior to purchase.
• Common examples include clothes, carpets,
household and office furniture, car etc.
• Experience goods: Experience goods are those whose
attributes can only be determined when they are
consumed, after they have been purchased.
• Common examples include foods, toothpaste,
washing-up liquid.
• A credence good: A credence good is one whose
quality cannot easily be assessed before or after
consumption, because a judgment about quality
requires the consumer to have specialized knowledge
of the product or service.
• Common examples are dental services, medical care,
car repair services and (perhaps) university courses.
• The probable effectiveness of persuasive advertising
differs systematically between search goods and
experience goods.
• There may be a role for informative advertising of
search goods, to ensure consumers are aware of the
product’s price, capabilities or existence.
• But persuasive advertising of search goods is unlikely
to be effective, because it is easy for consumers to
assess the quality of the product for themselves
before deciding whether or not to purchase.
• The truth (or otherwise) of advertising claims about
the qualities of search goods is in any case
transparent.
• For experience goods, in contrast, there is likely to be
a role for both informative and persuasive
advertising.
• If consumers cannot assess the quality of the product
for themselves prior to purchase, the purchase
decision may be swayed by persuasive advertising.
• The truth (or otherwise) of advertising claims about
the qualities of experience goods only becomes
apparent after the consumer is already committed and
purchase has already taken place.
• Accordingly, advertising intensity is likely to be
higher for experience goods than for search goods.
• Applying similar reasoning, both informative and
persuasive advertising may be effective in the case of
credence goods.
• Frequency of purchase may also have implications
for the effectiveness of persuasive advertising,
especially in the case of experience goods.
Convenience goods:
• Convenience goods are goods that are relatively
cheap and that are purchased frequently.
• For such products, consumers are unlikely to search
for detailed information prior to purchase, and are
unlikely to be persuaded by advertising that the
brands they consume have qualities other than those
consumers can discern for themselves.
• Example: salt, bread
Shopping goods:
• Shopping goods are expensive and purchased
infrequently.
• For products that are purchased less frequently,
consumers may be more open to persuasion through
advertising prior to purchase.
• Example: Clothes, refrigerator, car etc.
• For example, washing-up liquid and hi-fi equipment
are both experience goods, because their qualities
cannot easily be identified prior to purchase and
consumption; but washing-up liquid is a convenience
good, while hi-fi equipment is a shopping good.
• Bin-liners and furniture are both search goods,
because their qualities can easily be assessed prior to
purchase and consumption, but bin-liners are a
convenience good, while furniture is a shopping
good.
• Advertising might sometimes have a role to play in
signalling quality to consumers. The content of the
advertising message itself may be irrelevant, but the
very fact that a brand is advertised heavily suggests
the producer is confident that consumers who try the
brand will be satisfied, and will make repeat
purchases.
• Many consumer durables, such as cars, washing
machines, and audio-visual equipment, can be
classified as experience goods and as shopping
goods.
• Other things being equal, the infrequency of purchase
might suggest advertising intensities for shopping
goods should be higher than for convenience goods.
• But there is a countervailing factor. Shopping goods
are expensive, and their purchase accounts for a large
proportion of a typical consumer’s budget.
• When purchasing shopping goods that are also
experience goods, consumers are likely to make
efforts to gather reliable information about the
attributes of competing brands.
Advertising as a Barrier to Entry
• Advertising strategy can act as a barrier to entry in
several ways:
• The need to advertise increases start-up costs.
Entrants may need to spend heavily on advertising in
order to establish name recognition and a presence in
the market.
This raises entrants’ initial costs.
It may be difficult for an entrant to raise the required
finance because the returns to advertising outlays are
usually uncertain
• High levels of advertising build up reputation
effects.
Past advertising by incumbents creates goodwill and
strengthens consumer brand loyalties.
These advantages may be difficult for entrants to
overcome.
Reputation effects may be particularly strong for
first-movers: firms that have in the past pioneered a
product or brand.
Pioneering firms are often able to shape consumer
tastes in favor of their own products or brands
An incumbent firm may benefit from an absolute cost
advantage in advertising if its past advertising
investment has helped establish name recognition or
brand loyalty among consumers.
• Economies of scale in advertising.
there are two sources of economies of scale in
advertising.
First, firms must advertise a large number of times
before advertising messages permeate the minds of
consumers, and produce increased sales.
Second, large-scale advertisers may pay less per unit
of advertising than small-scale advertisers.
Economies of scale in advertising may also make it
difficult for small-scale entrants to compete
effectively with incumbents who are already
producing and advertising on a large scale.
Advertising, Information Search and
Quality Signaling
1. Advertising makes information search easy
2. Advertising is an indicator/signal of quality product
• If information is imperfect or if there is an
informational asymmetry between producers and
consumers, consumers may not be capable of making
an informed choice about the products and services
they purchase.
• This may have serious implications for the
effectiveness of competition and the nature of market
equilibrium.
• Advertising improves the speed and efficiency with
which consumers search for information.
• Consumers gather information through a search
process, which imposes costs in the form of wages or
leisure time foregone.
• From the consumer’s perspective, advertising reduces
the cost of obtaining this information.
• Equivalently, if products are heavily advertised, the
consumer can obtain a given amount of information
more cheaply, since the information obtained from
advertisements reduces the need for independent
search.
• Advertising also plays an important role in some
signalling models, which deal with situations of
asymmetric information between producers and
consumers.
• It is not worthwhile for a low-quality producer to
advertise its brand as high quality, because consumers
who are initially misled into purchasing the inferior
brand discover from experience that the brand is low
quality, and will not make the same mistake again.
• However, it is worthwhile for a high-quality producer
to advertise, because consumers who purchase this
brand and confirm from experience that it is high
quality will make repeat purchases.
• In the signalling model, it is not the advertising
message itself that is effective in convincing
consumers that the advertised brand is high quality.
• Rather, the simple fact that this brand is being
advertised provides the necessary signal of high
quality.
• Consumers realize the producer only advertises if it is
confident of attracting repeat purchases.
• Similarly, the fact that the low-quality brand is not
advertised provides a signal of low quality.
• The content of advertising messages may be
unimportant, but the fact that a producer is prepared
to invest in advertising suggests the producer is
confident that consumers, having made an initial
purchase, will return and make repeat purchases
• Consumers realize that if the brand was high quality
the producer would advertise, therefore the fact that
the brand is not advertised signals that it is low
quality.
Is there too much advertising?
• Advertising is often categorized as either
informative or persuasive.
• Informative advertising is widely regarded as useful
because it provides consumers with information with
which they can make more informed choices.
• Persuasive advertising, in contrast, distorts the
information consumers receive, making it more
difficult for them to make informed choices on the
basis of objective information.
• Reliable information is a prerequisite for effective
competition, which ensures resources are used
efficiently to produce the goods and services that
consumers actually want.
• Persuasive advertising changes the preferences of
consumers and might even damage competition, if
firms that have invested in building up brand loyalties
exploit their market power by charging higher prices
and earning abnormal profit.
• The responsiveness of sales to the volume of
advertising expenditure is shown by figure below
Sales
Sales
Advertise
• Increase in advertisement first increases sale, then
sales reach maximum then decreases
• Thus there is diminishing returns to Advertisement
• Any further advertising beyond a certain level has a
harmful effect on sales: consumers become fed up
with receiving the firm’s advertising messages, and
stop buying the product or brand.
• Some economists believe advertising tends to mislead
or distort the truth, and is usually wasteful or even
damaging.
• Others argue advertising contributes positively to the
circulation of information through society, and in any
event consumers have choices and are not forced to
purchase advertised goods if they do not wish to do
so.
• Perhaps this debate will never be resolved
conclusively.
• However, some of the empirical evidence, at least,
seems to suggest that advertising has beneficial
effects for competition and for consumers.
