J546 Exam 1

Advertising's Effect on Primary Demand

-Effect is similar to "agenda-setting" *Increasing the salience of a given product category -If advertising pushes out primary demand: *Advertising helps competitors as well -However, research shows that effects on primary demand are limited *Ex. Many studies show that the TV ban on ads for cigarettes (1970) has little effect on smoking *Would you drink less soft drinks if soft drink ads were banned?

Non-Convenience Goods Retailers

-Ex. Auto dealers, appliance stores, furniture stores, etc. -Play a more significant marketing role -Retailer is often asked to provide info about the product, demonstrate it and relate it to the store's image -More manufacturing advertising dollars are spent promoting the product to the trade (push strategy) in order to gain additional outlets -Consumers spend more time looking for the "best buy" -The brand name, developed through manufacturer advertising, may not be all important; store and cooperative advertising may be just as important -As a result, manufacturers prices may be lower to maintain distribution in critical stores

Convenience Goods Retailers

-Ex. Gas station, convenience food store, traditional supermarket, etc. -Provide display space for the manufacturer's product but that is about the only service offered -Manufacturer has already differentiated the product with the advertising to create demand and eventually develop brand loyalty among consumers -Manufacturer then increases prices to the retailer, reducing trade margins -Retailers are willing to accept price increases because of higher product turnover -Consumers engage in a limited info search because of the lower cost of these items

Role of Government in Market Failures

-Govt. should correct market failures *Help market conditions meet assumptions *Most govt. activities are attempts to correct market failures ~Income tax, social security, welfare, tax incentives for corporations, anti-trust legislation, tariffs, luxury/sin taxes, environmental regulation, etc. *Most govt. agencies prevent market failure ~EPA, IRS, FBI, FCC, etc.

Size of Effect on Selective Demand

-Greater ad expenditures associated with greater market share *In part, this is an artifact of pegging expenditures to sales *Even so, there is an independent effect -Size of the effect depends on: *Quality of the campaign *Quality of the product *Economic conditions *Product life cycle *Shape of the ad-to-sales response function

Advertising's Impact on Profits

-How much does advertising increase profits? -Profits are more important than market share *A firm with smaller market share can be more profitable -Profit concepts: *Profit = total revenue - total cost *Total Revenue = price x quantity sold *Product Price = cost + profits Advertising increases: -Sales -Costs -Which does it increase more?

Typology of Market Failures

-Imperfect Competition -Excessive Competition -Anticompetitive Conduct -Imperfect Information -Side Effects -Public Goods -Demerit Goods -Income Maldistribution

Excessive Competition

-Nature of failure: Fluctuating supply/demand -Ex. Trucking

Two Schools of Thought About the Economic Effects of Advertising

1. Advertising = Market Power 2. Advertising = Market Competition

Media

Conduits for delivering messages targeted at consumers (digital, print, broadcast, etc.). Strategic messages designed to influence knowledge, attitudes, values, perceptions and behaviors related to consumption, as opposed to other media roles like news and entertainment.

Advertising Side Effects

Does advertising promote innovation? Does advertising lead to excess consumption? Does advertising lead to pollution/garbage? Are the costs of advertising recognized by consumers? -Does it add to the costs of consumer goods? What are the norms and values transmitted by advertising? -Prosocial or antisocial?

Advertising as Information

Does advertising provide useful information? -Does it help consumers make educated decisions? Does advertising provide distorted information? -Does it lead to bad purchases? -Does it differentiate meaningless attributes?

Advertising's Effect on Selective Demand

-Advertisers are convinced it's substantial *$149.6 billion in 2006 *Was projected to hit $495 billion by 2013 *No doubt higher now -Evidence is clear cut: good advertising has substantial effect

Market Power School

-Advertising critics -Advertising as a persuasive/manipulative force (Vincent Norris) -Consumers become less concerned with price -Provides many advantages to heavy advertisers *Charge more, gain market share -Advertising disables market mechanism -Advertising increases consumer prices

Market Information School

-Advertising defenders -AKA Market Competition School (Charles Sandage) -Advertising stimulates competition -Advertising provides info for our informed decision -Advertising decreases consumer prices

Summary of Economic Issues to be Addressed

-Advertising's effect on consumer demand *Aggregate consumption, primary demand, selective demand -Advertising's effect on prices -Advertising's effect on corporate profits -Advertising's effect on concentration/competition -Advertising's effect on product innovation

Flaws of Market Power Model

-Assumes that advertising is probably sole cause of brand loyalty and price insensitivity, disregarding other factors

Flaws of Market Competition Model

-Assumes that consumers engage in a thorough and extensive search of product/service alternatives that is facilitated by advertising -Assumes that consumers are excellent judges of the merits of competing brands

Selective Demand

-Demand for a particular product -More specific than aggregate consumption or primary demand -Advertising's impact on market share

Advertising Effect: Increasing Demand Inelasticity

-Does advertising make demand curves more vertical/steep?

Examining the Advertising --> Aggregate Relationship

-How should we measure the relationship between advertising and aggregate consumption? -Problems with measuring this relationship: *How do you find a control group (without advertising)? *Most research involves trend data ~Time series data looking at fluctuations in advertising expenditure and consumption rates over time

Conclusions on Ad-Sales Response

-Increasing ad expenditures leads to higher sales *But for each additional $ spent, incremental increase in sales gets smaller diminishing returns -Results were counter to conventional wisdom and surprisingly consistent -Implication: many firms over-advertise *Ceiling effect on returns

Social Systems (Micro vs. Macro Effects)

-Individuals -Family systems -Neighborhoods -Municipality -State and regions -Nations -Global system

Advertising's Effect on Aggregate Consumption

-Intuitively, we'd be quick to accept the premise that advertising stimulates higher consumption -However, research shows that the relationship is more complicated; different researchers reach different conclusions -Logic behind the assumption: *Advertising --> Aggregate Consumption *Similar to "hypodermic needle"/"magic bullet" model of media effects *But these are not really good models - research shows that media effects are much more complicated; consumers have a more indirect response to advertising

Which model is correct (S Curve or Downward Concave)?

-Lit. review by Simon and Arndt -Advertising expenditures measured in several ways (x-axis): *Physical ~Increasing size of ads ~Increasing length of ads ~Increasing number of exposures *Monetary ~Increasing dollars spent on advertising -Findings: *Physical measures: ~Numerous studies produce consistent results ~Shape of the curve is downward concave ~Counter to conventional wisdom *Monetary measures: ~Because advertisers get discount for larger ad buys, we'd expect inflection point ~However, virtually all studies point to downward concave curve Conclusion: Downward concave curve is correct - S curve is not. There is no such thing as the "inflection point." It's a myth. Significance: Companies spend too much on advertising because they believe in the S curve, cutting into their profits

Income Maldistribution

-Markets fail when there is incongruence between economic nd social value, or when income does not reflect true economic value -Includes: *Factor Market Failures (all market failures discussed; each lead to misallocation of resources and affect distribution of wealth) ~Nature of failure: Any of above ~Ex. Employee discrimination *Economic vs. Social Value (people may not possess sufficient economic resources to earn an income which is consistent with social values) ~Nature of failure: Earned income not equal to social worth ~Ex. Children; disabled; superstars *Intergenerational Transfers (differences in interpersonal transfers of wealth) ~Nature of failure: Inconsistency with value that income be "earned" ~Ex. Inheritance; socially advantaged upbringing

Forms of Mediated Strategic Communication

-Product (brand) advertising *Almost never mentions price -Retail advertising *Target, Walmart, Bestbuy, etc. *Do see price *Tends to drive prices down -Service advertising *Lawyers, doctors, dentists, etc. -Trade advertising (B2B) *One business advertising to another business -Industry advertising *Industry as a whole comes together to advertise *Ex. Milk producers engage in "Got Milk" campaign *Benefits whole industry not just one brand -Classified advertising *Newspapers, Craig's List, etc. -Corporate advertising (PR) *Promote good image, crisis control, etc. *Issue ads to persuade public one way or another about certain hot topic -Political advertising *Senate/presidential campaigns -Public service advertising *Tries to help people, educate them *Volunteer, charity, etc.

Consumption

-Should consumption be a standard of success? -Economist Adam Smith: *Production and consumption are not as important as meeting the needs of the people *Consumption is not a good indicator of whether needs are being met -Raises important questions: *Does advertising lead to satisfaction or more desire? *What kind of consumption does advertising encourage? *Does consumption lead to happiness?

Imperfect Information

-Subjects to exchange are not fully informed about object of exchange and conditions in other markets due to highly complex economy -Includes: *Bounded Rationality (info has value only if subject has knowledge needed to use it; given limits of people's brains, can predict that many exchanges will not be fully informed) ~Nature of failure: Uninformed exchange ~Ex. Professional services *Info Costs (Subjects often act without info because of the cost of obtaining it) ~Nature of failure: Uninformed exchange ~Ex. Life insurance *Asymmetric Info (Subjects who engage in many exchanges involving same object will have an info advantage) ~Nature of failure: Unequal bargaining ~Ex. "Lemons" *Misinfo (Sellers have economic incentive to misinform buyers - buyers often unable to distinguish true from false) ~Nature of failure: Misinformed exchange ~Ex. Wonder Bread *Lack of Info (Both buyer/seller may not be aware of important forthcoming info about the product) ~Nature of failure: Uninformed exchange ~Ex. New therapeutic drugs

Basic Limitations of Many Economic Studies on Advertising

-There is the implicit assumption that advertising works in isolation rather than with other elements of the marketing mix -External environmental factors that influence effectiveness of advertising efforts are often not considered *Demographic (age, race, class, etc.) *Economic (GDP, interest rate, household income, etc.) *Political/Legal/Regulatory (federal/state policies, regulatory agencies, etc.) *Technological (development of new products that facilitate the marketing process, etc.) *Sociocultural (lifestyle patterns, values, belief systems, etc.) -Ignoring the economic effects of cooperative advertising allowance made to retailers -Necessary info is often unavailable or if available, is inaccurate/untrustworthy -Firms are not equally effective in the development and transmission of their advertising -Few economic scholars are conversant with basic material on consumer behaviors

Imperfect Competition

-Unequal bargaining positions -Includes: *Natural monopoly (only one producer can produce at minimum cost) ~Nature of failure: Economies of scale ~Ex. Electric utilities *Monopoly(sony) (one seller/buyer has power because it is the only available subject to exchange) ~Nature of failure: Bargaining power ~Ex. Standard oil *Oligopoly(sony) (sellers/buyers have power because too few sellers/buyers) ~Nature of failure: Independent conduct ~Ex. Tobacco *Monopolistic competition (large number of sellers/buyers still have power over each other because transaction costs inhibit competition) ~Nature of failure: Transaction costs; excess capacity ~Ex. Retail sale of convenience goods

Units, Variables & Levels

-Unit of analysis (object that we study) *Individuals, families, organizations, societies -Variables *Age, household income, number of employees, GNP (gross national product), etc. -Levels of analysis (nature of explanation) *Micro (individual differences) to macro (group differences) *Ex. Poverty leads to crime --> If you don't have money, you may resort to drug dealing to make some = Micro *Ex. Inequality leads to crime --> Black lives matter --> Whole groups rebel = Macro

Public Goods

-When goods cannot be privatized, exchange fails because of "free rider" problem; though individuals can benefit from good, no incentive to buy unless enough others purchase - then non buyers can still enjoy benefits -Nature of failure: Indivisibility; non excludability; zero MC -Ex. Street lighting; parks; national defense

Side Effects

-When the terms of exchange don't incorporate all the consequences of production and consumption of object of exchange -Includes: *Internalities (side effects are born by a subject of exchange but transmitted through other markets) ~Nature of failure: Transmittal of costs to non subjects ~Ex. Health effects of tobacco *Negative Externalities (negative side effects of production/consumption borne by non subjects leading to overproduction and consumption distorting resource allocation) ~Nature of failure: Overconsumption; costs imposed on non subjects ~Ex. Air pollution; communicable diseases *Positive Externalities (When some of the positive effects of production/consumption are realized by non subjects, the result is underproduction and consumption) ~Nature of failure: Underconsumption; benefits accrue to non subjects ~Ex. Inoculations against communicable diseases

Do markets meet these social good assumptions?

-Whether assumptions are met is open to interpretation *Some individuals believe most markets meet these assumptions *Others say that market failure is frequent and action needs to be taken -Who is right is a matter of debate

Economic Basics: Demand Curves

A economic curve where when price goes up, quantity goes down; when price goes down, quantity goes up. Using this curve, there are two questions that this graph illustrates: 1. Primary Demand: Placement of the demand curve 2. Demand Elasticity: Slope of the demand curve

Elastic Demand Curve

A horizontal economic curve. Demand is sensitive to price fluctuations. When the price rises, demand decreases sharply. Elastic products tend to be: -High levels of competition in the market -Many alternatives -Product not a necessity -Luxury items Ex. Soft drinks (other beverages); cars (many alternatives); mink coats (luxury item)

Oligopoly

A market in which control over the supply of a commodity is in the hands of a small number of producers and each one can influence prices and affect competitors

Monopsony

A situation in which there is a single buyer of a particular good or service in a given market. Ex. Govt. buying defense industries (military style weapons)

Inelastic Demand Curve

A vertical economic curve. Demand is insensitive to price fluctuations. When the price rises, demand does not decrease sharply. Inelastic products tend to be: -Low levels of competition in the market -Few close alternatives (limited substitutes) -Product is a necessity Ex. When your car gets towed; Uber flare prices; gas (necessity); toilet paper (necessity)

Primary Demand

AKA, "industry demand," demand for a particular product category

Reading 2

Advertising and the Economy (Rotzoll, Haefner)

Where does advertising fit into market theory?

Advertising can: -Cause market failures -Contribute to market failures -Prevent market failures Thus, advertising can be both a problem and a solution

Difference between collusion and cartel?

Collusion: The criminal (in the US) act of price-fixing Cartel: The group of companies coming together to do it

What happens when markets don't meet these assumptions? Market Failures

Correction for market failures: -Regulatory action by govt. *Market failures justify govt. intervention -Govt. must restore market assumptions Much of govt. policy debate is over identification of market failures -Disagreement over what constitutes failures *As well as how it should be fixed and who should do it -Framework provides playing field by framing the debate

Advertising and Demand

Demand curves can represent the demand for a product category or for a particular brand Effect of advertising on brand: -Does it push out the demand curve? (Make us want to buy more - increase demand at a given price)

Public Policy Debate

Determining whether market failure has occurred -Subjective decision -Underlying issue of most policy debates -When do small market failures cross the line? Market Theory Framework -Identifies nature of problems -Provides rationale for fixing the problem

Advertising and Competitive Conduct

Does advertising encourage competitors? -Does it breakdown barriers to entry? Is advertising used as a weapon? -Does it create barriers to entry that scare away potential competition? -Does it distract consumers from important aspects of transaction decisions by diverting them to less relevant product details? -Does advertising make consumers less willing to consider substitutes?

Advertising and Market Concentration

Does advertising stimulate or inhibit competition? -Does it increase awareness of substitutes? -Does it increase concentration? -Does it promote barriers to entry? -Do heavy advertisers control the market? -Do markets with heavy advertising become more or less concentrated?

Advertising Economics

Economics: the realm of advertising's supporters -Defense is based on advertising's informational role *Helping consumers make informed decisions *Facilitating and encouraging transactions Economics role is linked to the theory of capitalism -Legitimizes advertising as an institution

The Social Good

Evaluating functions and dysfunctions -Implicit concern for the social good -Normative concern: improving society Problem of subjectivity -How do we define the social good? -Will we ever agree on a definition? *Functions and dsyfunctions *What our social goals should be Where do we start? -Market Theory

Functions vs. Dysfunctions

Functions: Phenomena that have positive implications for social system or parts within that system. Ex. An ad carrying impotent info for making informed purchase decision Dysfunctions: Phenomena that have negative implications for social system or parts within that system. Ex. An ad carrying distorted or misleading info leading to bad consumer judgement -Some can be simultaneously both functional and dysfunctional (ad may sell products -functional to the producer but dysfunctional to the consumer - by misleading buyers) -Functions and dysfunctions are a matter of debate *Depends on perspective, who is affected and how, level within the system -Determining the net positive/negative is thus difficult

Advertising's Effects on Primary Demand

Impact of advertising dwarfed by other factors: 1. Economic Conditions -Expanding or contracting economy -Impact of ads in primary demand is largest during expansion periods 2. Nature of the Product -Effects on primary demand varies by product category -Effect is greatest on non-necessities 3. Stage of the Product Life Cycle -Introduction *New product developed and put on market *Product is not well known and sales are slow -Growth *Product gets known and sales start to climb *New competition enters market *Product margins are high -Maturity *Sales plateau *Advertising narrows to a fight for market share *Profit margins decline -Decline *Sales die off *Product becomes obsolete ---> Advertising's role changes over the Product Life Cycle *Early: ~Creating product awareness ~Kick starting demand ~Accelerating growth of product *Product hits market saturation point ~Primary demand doesn't increase ~Advertising shifts to market share fight *Content changes too ~Shifts from "information" to "persuasion"

Classic Liberalism Theory and the Social Good

In American society... -The market is the primary determinant of the social good Firm belief in functions of the market -Assumptions of Market Theory -Firmly adhered to in political rhetoric -Often ignored in practice *Ex. Ownership concentration The market (mechanism) determines: -What will be produced -Who shall receive what -How priorities are established -Who gets what rewards: Social Darwinism Market defines and leads to the social good -Consumer sovereignty (self-correcting market)

Disciplines of Injury

Level Fields -Analysts who share the same level of analysis -Examine different phenomena from same viewpoint Ex. Psychology, sociology Variable Fields -Analysis who share the same variable/process of interest -Examine same phenomenon from different viewpoints -Ex. Economics, political science, communication

Demerit Goods

Merit Good: Goods that are good for you/society; correspond to values Demerit Good: Goods that are bad for you/society; go against values -Too many demerit goods and too few merit goods lead to failure of social control -Nature of failure: Divergence of private wants; social values -Demerit Goods Ex. Gambling; prostitution; alcohol -Merit Goods Ex. Education

Typology

Static system of classification

Reasons for Lack of Effects on Consumption

Why does advertising follow consumption? 1. Method of setting ad budgets -Traditional approach is to peg to past sales -Sales go up, expenditures go up *Ad spending responds to sales 2. Advertising may increase prices, suppressing consumption 3. Competition among advertisers cancels each other out -Which product, not how much, to buy -Ad effects may be larger on market share (selective demand)

Push vs. Pull Marketing

Push: Involves taking the product directly to the customer via whatever means, ensuring the customer is aware of your brand at the point of purchase. "Taking the product to the customer." Ex. Trade show promotions, packaging designed to encourage purchase, etc. Pull: Involves motivating customers to seek out your brand in an active process. "Getting the customer to come to you." Ex. Word of mouth, discounts, customer relationship to company, etc.

Anticompetitive Conduct

-Collusion; predation -Ex. OPEC cartel; AT&T; MCI

Types of Market Failures

1. Imperfect Competition -Parties to the exchange have unequal power *Prices pushed above or below fair market value -Lack of competition (alternatives) among: *Sellers (monopoly) *Buyers (monopsony) 2. Excessive Competition -Too much or too aggressive -Producers cut quality to compete *Ex. Surge suppressors in VCRs; Ford Pinto (if it got rear ended, it would burst into flames - design flaw, however, engineers knew about it but didn't want to spend the money to add the extra part to fix all the cars. Ultimately, they got sued after some consumers died) -Sabotage or deceptive practices emerge 3. Anti-Competitive Conduct -Producers work together to disable a market mechanism -Collusion (companies illegally come together to increase prices for the same product); cartels (group of suppliers work together to fix prices); price-fixing -Ex. Collusion: Coke and Pepsi agree to both raise prices to $5 a can - price-fixing -Ex. OPEC, DeBeers 4. Imperfect Information -Parties to the transaction lack essential info *Leads to poor decision-making -Info is misleading, withheld or not available -Ex. Ford Pinto, Volkswagon crisis(?) 5. Externalities (side effects) -Negative side effects *Ex. Cost of cleaning up pollution -Positive side effects *Third parties benefit from exchange *Exchanges don't take place or are underutilized ~Ex. Inoculations or solar energy 6. Public goods -Goods and services that the free market does not provide *Ex. Roads; bridges; airports; schools; space program -Too expensive to build/purchase -Not viable as a commercial entity *Ex. Excludability problem of roads -Govt. provides what market will not 7. Merit and Demerit Goods -Merit Goods: Good things that need to be subsidized *Ex. Solar energy, water fluoridation, etc. *Need to be provided/encouraged for public good -Demerit Goods: Bad things that need to be controlled *Ex. Gambling, drugs, prostitution, alcohol, tobacco , etc. 8. Maldistribution of Wealth and Income -Worst of all market failures -Incomes not proportionate to contributions -Very difficult to find consensus *Ex. Golfer vs. garbage collecter (huge difference in income) -In this society, it is often resolved tautologically *"You are worth what you get paid" *Under this logic, market failure is not possible *Yet, the US has serious wealth polarization

Market Power vs. Market Information

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Basic Economic Issues

1. Advertising and Price -Q: Does advertising lead to lower or higher prices for the consumer? -Depends if retail or national - retail generally lowers; national generally highers 2. Returns to Advertising Q: Is advertising efficient in terms of returns? -Large firms can more easily achieve profit and effectiveness 3. Advertising's Effects on Profits -Q: Does advertising have an effect on a manufacturer's profit rates? -Inconclusive but believed to be a general positive relationship 4. Advertising and Concentration -Q: Does advertising lead to higher concentration in consumer goods industries? *Yes but evidence that relationship not so simple; depends on specifics -Based on ranking of firms in industry in order of size starting with largest *Percentage of each firm's sales out of total industry sales is derived *Then top firms' percentages are added to obtain concentration ratio *Assumed (especially by market power school) that advertising expenditures are related to measures of concentration; advertising causes high concentration levels because: a) Efficiencies in returns to advertising would enable large-scale advertisers to push smaller advertisers out of the market b) Increased capital requirements and brand loyalty would discourage potential entrants 5. Advertising and Aggregate Consumption -Q: Does advertising have an effect on aggregate consumption? -There are high correlations between advertising and aggregate consumption; this is improved when advertising is moved from cause (preceding consumption) to effect (behind consumption) -National advertising does not affect total spending for goods and services -Most evidence indicates that advertising is the result rather than the cause of consumption, however, confounding findings mean results not clear 6. Advertising's Effect on Primary Demand -Q: Does advertising have an effect on primary demand? -Primary demand is demand for all brands, advertised or not, within a given product category -Basic trends of demand for certain products (determined by social and environmental conditions) are more better for determining the amount of overall product demand than looking at how advertising was used/not used -The main impact of advertising is on a consumer's choice of brands or products within a particular class rather than across diverse classes

5 Major Methods of Social Control

1. Authority -Public policy -Difficult to establish, expensive to administer -Strong preferences for restricting use 2. Exchange 3. Persuasion 4. Morality 5. Tradition

Why do firms over-advertise?

1. Belief in the S curve -Concern about getting past the inflection point 2. Don't measure advertising sales response, just assume/do what their ad agency tells them -Measurement is difficult 3. Ad agencies and conflict of interest -Traditional billing: agencies get a commission on ad buys *The more the client spends, the more the agency makes *Similar to stock broker's commission -Agencies want to "maximize" rather than "optimize"

New Approaches to Studying Economic Effects of Advertising (Porter, Steiner)

1. Convenience Good Retailers vs. Non-Convenience Good Retailers (Porter) *Advertising as economists study it may be more important for convenience goods retailers; retailer is integral part of model 2. Advertising is seen as increasing distribution and thus potential users while diminishing gross margins earned by retailers; at same time allows factory prices to increase more than consumer prices (Steiner) *One of three situations typically occur during the process: 1. Manufacturer's brand domination -Ex. Aspirin, detergent markets, etc. 2. Mixed regimen -Retailers market manufacturer's brands and their own private labels 3. Private label domination Ex. Produce, meat, lumber markets, etc. *Retailer is also integral part of model

Implicit Questions for the MI/MP Debate?

1. Does advertising shape people's perceived needs and preferences? 2. Does advertising manipulate desire? 3. Does advertising break down rationally? 4. How do consumers evaluate product info from advertising?

Key Philosophical/Epistemological Questions

1. How do we define rationality? -MI tends to define rationality tautologically (true by definition) *Ex. If consumer does something, there must be a good reason -MP says that consumers often make irrational decisions *Irrational decisions are encouraged by advertising Ex. Is this rational? -Roberto Cavalli at Nieman Marcus *Blouse $745 *Jeans $2,025 *Grand total: $2,770 -Rational or not? Subjective - no right answer

Subcategories of Imperfect Information

1. Information costs (expensive or difficult to get) 2. Asymmetric information (one party has more info) 3. Misinformation (one party gives out bad info) -Ex. Buying a used car 4. Lack of information -Ex. Thalidomicide (sleeping pill that led to birth defects and leprosy) 5. Information is the object of the exchange -Ex. Software, movies/music, treasure amp 6. Bounded rationality (problem with person using this info) -Lack of understanding go the info -Failure to recognize importance of info -Info is ignored -Ex. Cigarettes, drunk driving, etc. - know it's bad for you but do it anyway

Why do we study advertising?

1. It is a major US business, with over $140 billion spent annually 2. It is a highly visible institution, touching most businesses and consumers every day 3. Common belief among business people that advertising "sells" the product or service. If sales down, advertising to blame; if sales up, advertising gets the credit.

4 Subcategories of Imperfect Competition

1. Natural Monopoly (Natural Monopsony) -It's only practical to have one buyer or seller -Ex. Power company; phone company; cable -Ex. Govt. as buyer for military weapons 2. Monopoly (Monopsony) -One company dominates (competition is possible) *Other companies driven out or never got started (barriers to entry) *Ex. GE lightbulbs, Microsoft, Zamboni *Ex. One company town (monopsony) -Monopolies drive prices up, monopsonies drive prices down 3. Oligopoly (2-3 firms dominate) -Collaboration (Ex. price-fixing) is possible 4. Monopolistic Competition -Sellers have control over buyers because of high transaction costs -Ex. Campus grocery stores

9 Conditions for Market Success

1. Perfect Competition -Subjects to the exchange should have relatively equal bargaining power 2. Perfect Information -Subjects should be fully informed about object of exchange and all possibilities (price, product attributes of substitutes, etc.) 3. Absence of Externalities -All consequences of exchange should be internalized in exchange 4. Divisibility -Object of exchange should be divisible into exchangeable units 5. Excludability -Subjects of exchange can exclude non-subjects from benefits of exchange 6. Zero Transactions Cost -No barriers to exchange -Market instantly clears at a price that equals out supply and demand 7. Zero Entry Barriers -No long-term supply constraints that inhibit additional production when demand exceeds supply in the short-term 8. Economic Rationality -Subjects to the exchange act to maximize their individual self-interest, measured in materialistic terms 9. Fair Distribution of Wealth and Income -Distribution of economic resources available for exchange consistent with social consensus of fairness -Each individual has wealth and income that corresponds to his/her production of economic goods/services

Market (4 different meanings)

1. Region -Ex. Chicago, urban, midwest 2. Consumer Type -Ex. Women, Hispanic, upscale 3. Product Type -Ex. Tires, shoes, laundry detergent 4. Locus of Exchange -Consumer, B2B, institutional (schools, govts.), reseller (retailers)

Limitations of the Market as Determinant of the Social Good

1. Tautological (true by definition) -What "is" wouldn't be if the market didn't demand it -Ex. Kardashians, Coors Light - they "must" be good right? Subjective 2. Inherent defense of status quo (resistant to change) -This is what the people want 3. Shuts down questions about (accepting what is) -How things could be different/better 4. Predicated on human rationality -Are we always the best judge of... *Our personal needs? *Our societies' needs? 5. Predicated on the assumption of informed individuals -People make poor and uninformed decisions 6. Aggregation of individual decisions -Adding up individual decisions based in self-centered needs is not always the best way of producing the social good -Problems of individual decision aggregation: *Provides rationale for representative rather than direct democracy -Ex. Would we pay taxes? *Representatives make tough decisions on behalf of social good Where does this leave us?? -How do we identify social good? *Hammered out through discussion, deliberation ~In class... as it is in society -Unlike the market mechanism: *Its not one person, one vote *Better arguments carry more weight *Importance of informed debate and decision making

Comparison of Market Information and Market Power

Advertising's Basic Functions Compared: -MI: *Informs consumers *Teaches product attributes/alternatives *Does not alter consumer evaluations of attributes/alternatives -MP: *Affects preferences and tastes *Shapes perception of product attributes *Differentiates products and alternatives Consumer Buying Behavior: -MI: *Consumers become more price sensitive (aware of alternatives) *Buy best value *Price quality dimension is primary determinant of demand elasticity -MP: *Consumers become more brand loyal *Less price sensitive *Perceive fewer substitutes thereby decreasing demand elasticity Barriers to Entry: -MI: *Advertising makes entry possible for new brands *Allows them to publicize their existence -MP: *Advertising creates barriers - potential entrants must overcome established brand loyalty *High initial advertising expenditures required Industry Structure and Market Power: -MI: *Consumers compare competitive offerings *Competitive rivalry is stimulated *Efficient firms remain and inefficient firms die -MP: *Firms are insulated from competition and potential rivals *Concentration increases, giving producers more power Market Performance Summary: -MI: *Lower prices, increased competition, increased market efficiency (enhancing social good) -MP: *Higher prices and higher profits, decreased competition, decreased market efficiency (inhibiting social good)

Marketing Perspective

Approach of how advertising has been practiced since WWII. Changed the game; the way we look at and promote products.

Relationship between Authority and Exchange

If things are going well, there is a strong resistance against social control and authoritative intervention (Democratic society); if private actions meet social goals and values, there is resistance to authority intervening. But if things are going bad (failures occur), authority is employed to correct it. Failures are a result of a market not existing, is incomplete or is temporarily restrained.

Different Market Types

Auction Markets: -Ideally where identities of buyer and seller unknown to each other -Disinterested "auctioneer" matches up buy and sell orders -Focused on present transaction; past and future don't matter -Ex. Commodities, securities markets Bidding Markets: -Similar to auction markets, except auction is conducted by interested buyer or seller, rather than disinterested auctioneer -Ex. Oil leasing, govt. procurement Relational Markets: -Personal but not intimate relationship between buyer and seller -Meet in person, by phone or mail -Current transaction is influenced by past and future transactions -Ex. Retail goods, services markets Contractual Markets: -Contractual relationship between buyer and seller that transcends single transaction -Limited to one or a few objects of exchange -Ex. Long term supply contracts Franchise Markets: -Contractual relationship between buyer and seller that transcends single transaction -Covers wide range of goods/services -Ex. Retail franchises Obligational Markets: -Contractual relationship between buyer and seller spanning a period of time -Locus of exchange is shifted over the object exchanged to the buyer -Ex. Employee contacts, equity investments

Consumer

Citizens engaged in purchasing goods and services. Distinct from other human roles (worker, parent, spouse, etc.)

Market Mechanism

Helps bring about social good. Says that if producers are doing good (making useful products, good price etc.), they will be rewarded in sales. But if doing bad (too expensive, crappy product, etc.), market will punish you and people will not buy. Consumer is king. We decide what gets rewarded and what gets punished.

Market Theory Concepts

Human rationality assumption -Human beings are rational and make decisions in their best interest The Exchange Principle: -Exchanges make both parties better off *Transactions increase happiness/well-being -Assumption: People make good judgments -Net result of exchanges maximizes the social good Freedom of exchange: "Laissez faire" -Exchanges should be free of interference -Interference: *Keeps rational individuals from maximizing their own utility *Prevents social good from being maximized -Government should keep hands off the market *Except to correct "market failures" Consumer Sovereignty (the market mechanism) -Consumers as voters: *Deciding what is good and bad -The Self-Righting Principle: *Good products/services rewarded *Bad products/services punished -Producing the social good: *Aggregated exchanges by rational consumers *Individuals and society are better off *Market mechanism keeps quality of goods/services high Competition -Key to enabling the market mechanism -People need choices/alternative to make a difference -Competition keeps prices low The Social Good -"Pareto Optimality" - some better off and none worse off -Aggregated rational exchanges produces consumer sovereignty *Keeps quality high and prices low

Market Failures

If one or more assumptions is not met: -Market failures can occur -They are dysfunctional to the capitalist system If market failures occur: -Market mechanism is inhibited -System fails to maximize social good In most transactions: -One party is the buyer and the other is the seller -Many market failures have two versions: *One on the buyer side and one on the seller side *Ex. Monopoly (seller side power imbalance); monopsony (buyer side power imbalance)

Downward Concave Curve

Incremental increases in advertising expenditures lead to increase in sales but this increase in sales is smaller than the increase in advertising so eventually get nothing in return, leading to diminishing returns

Reading 1

Institutional Typologies of Market Failure (Harris, Carman)

Advertising = Market Power School of Thought

Main Idea: -Views advertising as a persuasive communications tool that marketers use to make consumers less sensitive to price; this decreased sensitivity subsequently increases the firm's market power. Advertising: -Advertising effects consumer preferences and taste, changes product attributes and differentiates the product from competitive offerings Consumer Buying Behavior: -Advertising is capable of changing consumer taste and building brand loyalty. Brand loyal customers are not very price sensitive - do not believe acceptable alternatives in the marketplace. Barriers to Entry: -Potential entrants must overcome established brand loyalty and spend relatively more on advertising Industry Structure and Market Power: -Firms are insulated from market competition and potential rivals; concentration increases, leaving firms with more discretionary power Market Conduct: -Firms can change higher prices and are not as likely to compete on quality or price dimensions. Innovation may be reduced. Market Performance: -High prices and excessive profits accrue to advertisers and give them even more incentive to advertise their products. Output is restricted compared to conditions of perfect competition.

Advertising = Market Competition School of Thought

Main Idea: -Views advertising as informative in nature and contends that it increases consumers' price sensitivity and stimulates competition among firms Advertising: -Advertising informs consumers about product attributes and does not change the way they value these attributes Consumer Buying Behavior: -Advertising provides basic info to the marketplace that will increase price sensitivity, lower prices and reduce potential monopoly power; consumers buy "best value" Barriers to Entry: -Advertising makes entry possible for new brands because it can communicate product attributes to consumers Industry Structure and Market Power: -Consumers can compare competitive offerings easily and competitive rivalry is increased. Efficient firms remain and as the inefficient leave, entrants appear; the effect on concentration is ambiguous Market Conduct: -More informed consumers put pressure on firms so lower prices and improve quality. Innovation is facilitated via new entrants Market Performances: -Industry prices are decreed. The effect on profits due to increased competition and an increase in efficiency is ambiguous

In order for the market to serve its social good, nine assumptions must be met:

Market Theory Assumptions: 1. Perfect Competition -Parties have equal bargaining power -One side can't dictate the terms of the exchange -Predicted on the availability of choices (alternatives/substitutes) -Q: How does advertising enhance or erode competition? 2. Perfect Information -Parties have the necessary info to make informed decisions -Absence of distorted, misleading or deceptive info -Parties understand the alternatives -Q: Does advertising provide good or bad info? 3. Absence of Negative Externalities -Externality: Side effect resulting from the transaction *Ex. Costs of fixing problems associated with producing, distributing, consuming and disposing of the product *Transaction should take such costs into account -Ex. Production: pollution; Distribution: destruction of roads by trucks; Consumption: health problems; Disposal: hazardous materials 4. Divisibility -Object of exchange must be divisible into exchangeable units *You can't sell something if you can't divide it into transferable units -Ex. The Berlin Wall; Camp Randall turf *Without divisibility, exchanges would not take place 5. Excludability -Uninvolved parties excluded from benefits and costs of the exchange *No "free riders" -Ex. Scrambling cable signals; music/movie pirating -Without excludability, exchanges are discouraged and supply is threatened 6. No Excessive Transactions Cost -Transaction cost: the cost of engaging in a transaction *Parties are not forced into exchanges because of costs of doing business elsewhere -Ex. US forced to import oil because: High exploration/extraction costs of domestic production, high R&D costs of alternative energies; small town hardware stores; campus grocery stores 7. No Barriers to Entry -Barriers: something that discourages new competitions -New firms must be able to join the competition -Ex. High cost of building new factories and training labor force; high advertising budgets -Q: Does advertising create or break down barriers to entry? 8. Economic Rationality -Transaction parties capable of making smart decisions - *Essential to maximizing individual and social good -Complication: short-term vs. long-term interests -Values and preferences are not corrupted into unwise decisions -Q: Does advertising enhance or erode rationality? 9. Fair Distribution of Wealth and Income -Income should correspond to individual contributions -Fair awards for contributions -Ex. Justification for the income tax

Workable/Effective Competition

Market competition where there is no regulatory response that would result in greater social gains than social losses

Problematic Situations for Imperfect Information

Product is expensive -Ex. Cars; houses; diamonds Purchase is infrequent (hard to correct) -Ex. Cars; houses; diamonds Performance characteristics are hard to observe Ex. Diamonds Rapid technological change -Ex. Betamax; Videodiscs

Market Share

Proportion of a product market controlled by a particular producer

Market Theory and Policy Debate

Representative Charles Boustany from Louisiana's 4 Proposals: 1. Public Goods 2. Competition 3. Public Goods 4. Merit Goods

Research Conclusions

Research fails to show consistent pattern -Lack of support for the argument that advertising expenditures increase overall consumption Some research indicates directionality is reversed -Aggregate Consumption --> Advertising Defense of advertising as economic engine is largely unsubstantiated -Economists skeptical of argument that advertising supports the economy

Advertising and Elasticity

The slope is different for different products: -Some products: Horizontal curve ("elastic demand") *Doesn't really fluctuate in response to price fluctuations -Some products: Vertical curve ("inelastic demand") *Fluctuates in response to price fluctuations

The Ad-Sales Response Function

Two competing models of the relationship between ad expenditures and sales: 1. The S-Curve -Conventional wisdom -Curve has an inflection "takeoff" point where sales response finally shoots up 2. The Downward Concave Curve -Competing argument of "diminishing returns"

Market Information School vs. Market Power School

Two competing schools of thought on the economics of advertising: -Market Information vs. Market Power *Diametrically opposed views (exact opposites) *Information = defensive vs. Power = critical -Definitive evidence is hard to find; varies from situation to situation

Advertising and Public Goods

To what extent does advertising subsidize mass media? Are there costs associated with this subsidy?

Aggregate Consumption

Total demand for all goods and services consumed in society -Relationship to GNP: *GNP: Production side *AC: Consumption side Common Assumption: -AC and GNP are positive -Considered desirable because relationships to: *Employment (creates jobs) *Standard of living *Consumer happiness -AC is a sign that goods/services are being exchanged *Both parties are better off We will temporarily ignore negatives of AC: -Ex. Pollution, garbage, depletion of natural resources, etc. -Ex. Social values, consumption fixation, etc.

Market Theory

Theory that consumers have all the power in the market because they have all the preferences, they can choose which competitor to use, firms can't raise prices, because their consumers will just leave. The basis of modern capitalism -Part of the Classic Liberalism tradition in economic theory (laissez faire) Provides framework for: -Assessing functions and dysfunctions -Identifying problems -Rationale for solutions (regulation)

Advertising's Effect on Consumer Demand

Three Levels of Consumer Demand: -Aggregate Consumption *Total demand for all goods/services -Primary Demand *Demand for a given product category -Selective Demand *Demand for a particular product

Examples of Market Theory

What is the impact of e-commerce (Ex. Amazon)? -Information (more info about alternatives?) -Competition (increase or decrease?) -Transaction costs (reduce?) What market failures might be triggered by (Ex. Craig's List)? -Information (sketchy info about products, buyers and sellers?) -Externalities (encouraging theft?) -Maldistribution of wealth (secondary markets)