Economics of advertising

Advertising is an invasive aspect of modern society. It is hard to look around without coming across advertising. In a way, advertising leads to deadweight welfare loss. The money spent on advertising goods does not increase their quality, nor does it increase the number of goods and services in the economy. However, it does cost a lot leading to higher prices for consumers.

A rational consumer could say. ‘The more a company spends on advertising the more expensive it will be, therefore, heavily advertised goods must offer the worst value’

However, most consumers do not think like this. They think, if the firm can afford to spend a lot on advertising it must be good. Therefore, they trust the good to offer a minimum standard of service.

Nevertheless, it is said advertising does create some benefits. In particular, it helps to improve the information for consumers.

Problems of advertising

• Invasive into modern life. We have no choice but to view advertising.
• Some advertising could be classed a demerit good. For example, firms have used sexually suggestive images to increase sales, but this creates problems in defining the image of women in society.
• Cost of advertising which doesn’t improve the product but ultimately leads to higher prices for consumers.
• Persuasive advertising. Attempts to get customers to buy products who are otherwise unlikely to purchase the good. Sometimes persuasive advertising can verge on the exploitative. For example, subliminal advertising messages are illegal in most countries.
• Creates barriers to entry. Why do Coca Cola and Pepsi spend so much on advertising? People know what Coca Cola is by now. One reason is that by spending so much on advertising it makes it very difficult for new firms to enter the market. They cannot compete with Coca Cola’s advertising budget, so they are discouraged from entering the market. Advertising is an example of a sunk cost (non-recoverable cost) and a barrier to entry. Therefore advertising can create monopoly power, which leads to higher prices for consumers.
• Advertising needs regulating to prevent firms from displaying false information and false claims.

Advantages of advertising

• Increases information. Consumers can be informed of new products.
• Advertising can be used to promote goods and services which improve public health, e.g. use of contraception.
• Consumers like buying goods where they feel they can rely on a minimum standard. They may not be buying the best value goods, but, at least they know they will not be buying a dud.
• Advertising is not all wasted resources. The advertising industry creates jobs and can create innovative ads. For example, John Smith ads featuring Peter Kay are worth watching purely for the comedic value.
• Advertising/sponsorship can be vital revenue for many businesses, social and charitable services. For example, print media relies on advertising to make the newspaper profitable. Without advertising space for sale, newspapers would be more expensive or there would be fewer for sale. Sponsorship of charitable events is a form of advertising which helps make the charity event to be more viable.
• Support for sporting events. After the financial problems of the 1976 Montreal Olympics, the Olympic movement secured the financial backing of major companies, who were able to advertise at the Olympics in return for guaranteeing the financial future of the Olympics.

Related

• Profitability of firms
• Economics of branding