| What is advertising | Advertising is a method of providing consumers with information about the product. |
| What are the main ways of advertising? | The main ways to advertise are: Over E-mail, telemarketing, TV commercials, ads in newspapers, flyers, in-store advertising, Internet cookies adn so forth. |
| Why is advertising used? | Advertising used to persuade consumers to understand / believe that there are real differences between products.
Advertising over longer period can create image, establish a brand and create loyalty intangible capital comparative advantage. |
| Can advertising be informative? | • Creates real information about the product that it exists and sold in certain localities
• Creates accurate information about product attributes and quality
• Socio-economically speaking, informative advertising real welfare improving, firm make the right choices - more efficient allocation
• Total surplus = Producers surplus + Consumer surplus increases |
| Can advertising be persuasive? | • Advertisements with content that is not necessarily correct.
• Advertisements that try to persuade the consumer to buy one product over another
• Persuasive advertising can be misleading and confusing and lead to an inefficient allocation of society's resources |
| What are the motives of advertising? | 1. To launch / promote new products (Especially important for new firms as they have no image on the market)
2. In order to give consumers information about price and quality
- Important, if the market is characterized by frequent changes in technology
- Important if Lemon problem: if on the market both high and low quality products (e.g. used cars) simultaneously sold and consumer do not know a used car's real quality, consumers will not want to pay a high price for quality car (because they don’t know whether it is good quality); but conversely also pay too much for the car of poor quality (lemon).
- Informative advertising can alleviate this problem (mentioned in the literature as Akerlofs theory): The markets for lemons (slang for low quality).
3. To increase / maintain its market share
- Gain market power
4. To establish / create a brand
- Differentiate its product from competitors’ product
- Raising barriers to entry for new businesses |
| Why is advertising a preffered way of competing with other firms? | Businesses often prefer non price competition. Firms want to risk avert towards putting prices down. Advertising is often an alternative. |
| How does the market structure affect the level of advertise? | If perfect competition advertising no effect, given perfect competition assumptions.
With Oligopoly (large companies are competing against each other) so that monopolistic competition can be strong incentives to advertise
If the market is monopolistic or characterized by strong barriers to entry is the incentive for advertising usually not as large as the oligopoly
Monopolist may (periodically) use advertising as a tool to keep potential entrants out of the market.
Finally, the answers may contain a reference to / use of Dorfmann Steiner conditions (more below) |
| How can advertising be an entry barrier? | Raising entrants’ initial costs:
- High advertising expenditures necessary to draw attention to entrants product
- Increase the sunk costs of potential competing interest
Building reputations effects:
- Existing companies may have created brand loyalty, influence consumer tastes by using advertising
Economies of scale in advertising:
- Cumulative effect of many commercials rounds - Increases sunk costs for potential competitors
- Promotional price per minute / cm less |
| What model can be used to examine the effect of informative advertising (consumer gain) ? | Notation:
MC: constant cost to the consumer by searching product information for another hour
MB1: The prize for the consumer by searching product information for another hour without advertising
Model implications:
• The consumer will seek information until MB1=MC => s1 search time.
• MB2: The prize for the consumer by searching product information for another hour with advertising The consumer will seek information until MB2=MC => s2.
• Notice at s2 < s2, i.e. advertisement reduce consumer search costs. |
| What is the Dorfman Steiner condition? | The Dorfman Steiner condition can find the optimal level of advertising. No need to be able to calculate but understand the formula! |
| What is version 1 of Dorfman Steiner condition? | We see that if there is a high price sensitivity, it makes sense to compete on price. If price sensitivity is low, advertising makes more sense. |
| What is version 2 of Dorfman Steiner condition? | We see that the higher advertising intensity, the higher the markup. If the company has a high markup, can get a larger reward to increase sales - for example using advertising. Therefore, an advertising strategy attractive. |
| Please provide a summary of Dorfman Steiner condition | Dorfman-Steiner condition should not be thought of an exact quantitative decision rule. Other factors might also important.
The rule is derived 'ceteris paribus' and ignores other strategic behavior, capacity and so on. However, the formula says that price elasticity of demand and the advertising elasticity of demand are crucial for the choice between a pricing strategy and advertising strategy.
In the alternative version (II) the interpretation focuses on the extra income which can be generate for every advertising amount spent. I.e. the higher the markup the more it pays to increase sales using advertising (among other strategies) |
