18_ad.dvi

“Last” class we talked about:
Summary from last class
• Price information, quality information.
• To “educate” consumers? provide infor- • But how informative is prime–time televi- • Outside economics, people tend to think advertising is about changing tastes.
• Persuasive versus informative advertising.
• Advertising is a big business.
• U.S. advertiser collectively pay more than all of the six countries that follow in spend- • Second: Japan, Third: Germany.
• Advertising provides 50% of revenues of • We will study the effect advertising has on prices, entry barriers and consumer welfare.
– Search goods (quality can be judged by
– Experience goods (quality can be judged
– Credence goods (quality cannot be judged,
Informational versus persuasive advertising
• Informational advertising: describing prod- uct’s objective characteristics (price, com-pare to rival’s prices, describe features, listuses).
• Persuasive advertising: make claims to stim- ulate purchase (cowboy riding into sunset),try and change consumers’ perception (repo-sition brand in product space: Dr Pepper).
– Producers of search goods are more likely
– Producers of experience goods are more
likely to use persuasive advertising.
– Three times more advertising on expe-
Profit–Maximizing Advertising
Advertising is designed to increase the demand Marginal cost of advertising = Marginal benefit More is advertised as the cost of advertising is • By 1630 printing allowed wide–scale adver- • Then radio and television.
• These days even internet.
Effect of Advertising on Welfare
Many social commentators attack advertising.
Yet it might be beneficial for consumers.
• Price advertising increases welfare.
• Advertising might solve the lemons prob- But, there also might be too much spent on Price advertising increases welfare
• Truthful advertising informs consumers where • Price advertising lowers market price (through • Because it’s costly, firms only advertise when • Empirical studies confirm this, sometimes coupled with decline in quality (legal ser- Advertising to solve the lemons problem
• Suppose low and high quality goods are indistinguishable at time of purchase (ex- • Advertising might solve lemons problem if • Repeated interactions necessary.
• Once consumers buy the good they will Excessive advertising
When products are differentiated, firm may en- gage in too much advertising (both persuasive • Unitl recently little could be said about ef- • If advertising “changes” consumers’ tastes, it’s tough to compare pre– and post–advertising Advertising till marginal cost equals marginal ⇒ At equilibrium, a small decrease in advertis-ing increases welfare.
Too much is spent on advertising (in this model).
Advertising as a barrier to entry
Persuasive advertising can be anticompetitive.
• Consumers might fall prey to spurious prod- • Potential entrants have to advertise exces- sively to overcome goodwill created by the • Depends on how long effects of advertising False advertisement

Source: http://www.sfb504.uni-mannheim.de/~grosskop/teaching/18_ad.pdf