Week 6 Lecture 3

Question 1

Define advertising

Answer 1

Advertising is a paid non-personal communication about an organisation (or presentation of its goods and services) transmitted to a target audience through mass media

Question 2

Explain the persuasive view of advertising

Answer 2

1- Meaning: Ads alter consumers tastes and wants. It causes market power, entry-deterrence, brand loyalty and product differentiation
2- Price effect: Ads lower price elasticity of demand and so larger sales may lead to economies of scale
3- Competition effect: Ads are anti-competitive. They soften price competition, creates barriers to entry and brand loyalty and intensifies product differentiation. Ads cause market power
4- Welfare effect: Ads are socially wasteful and excessive. Combative ads lead to social losses and have no social benefit

Question 3

Explain the informative view of advertising

Answer 3

1- Meaning: Consumers lack information about prices, product characteristics etc. Ads are a useful source of information that eliminates search costs
2- Price effect: Informative advertising eliminates search costs and expands demand
3- Competition effect: Price advertising causes price undercutting and toughens competition
4- Welfare effect: Consumers are better matched with the desired products and make informed choices

Question 4

Explain the complementary view of advertising

Answer 4

1- Meaning: Ads are good by themselves and are therefore components of utility functions
2- Price effect: Complementary ads increase the value of the advertised good
3- Competition effect: Complementary ads are usually anti-competitive
4- Welfare effect: Complementary ads improve social welfare if consumer surplus exceeds deadweight loss

Question 5

What is advertising intensity and state the formula used to calculate it

Answer 5

• Advertising intensity is a share of advertising expenditures in the
  total revenue
• Advertising intensity = Ads spending / Total revenue

Question 6

What does the model of optimal advertising show?

Answer 6

• The basic model of optimal advertising shows that advertising intensity positively depends on advertising elasticity and negatively depends on price elasticity of demand
• If consumers are more sensitive to ads then firms tend to enhance ad intensity
• If consumers are more sensitive to prices, firms tend to lower prices to increase sales