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Informative advertising: an alternate viewpoint and implications

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Since the early 1960's economists and marketers have hotly debated the role of advertising. One school of thought has focussed on the anti-competitive effects of advertising: how higher advertising in acategroy is associated with higher prices, profits and barriers to entry. An alternate school considers the informative nature of advertising and how information about product attributes allows consumers to find products that better match their needs. The author does not attempt to resolve this dispute. He seeks to offer a fresh perspective on the controversy by demonstrating that in certain situations, botheffects (higher prices and profits and better matching of consumers to products) are natural outcomes in a market with differentiated competitors. Moreover, the relationship between pricing and advertising is observed to be non-monotic as a function of the level of differentiation in the market. Our model considers a market where demand for a firm's products is driven by three factors: consumers' awareness of products and their attributes, pricing, and the degree of fit betweena product's attributes and the needs of the consumer. Following Salop (1979), differentiation is captured by representing the firms as equally spaced points in a unitary circular spatial market. The author assumes that product attributes, pricing, and the degree of fit between a product's attributes and the needs of the consumer. Following Salop (1979) differentiation is captured by representing the firms as equally spaced points in a unitary circular spatial market. The author assumes that product attributes are fixed and the firms make decisions about how much to advertise and what prices to set for their products. A distinct element of our model is the mechanism by which advertising makes consumers aware of products in the category. Similar to Grossman and Shapiro (1985), advertising is assumed to be a series of messages which are received randomly by consumers in the target population and consumers only have interest in a product if they have seen advetising about it. It is important to underline that advetising only affects consumers' awareness of a product and not their valuation of it. The primary finding of our analysis is that the impact of informative advertising on market prices and profits is a function of the pre-existing level of differentiation in the market. Advetising is observed to create distinct groups of consumers based on the advertisng to which they have been exposed. the optimal pricing is a function of competing firms balancing the needs of each of the groups that have an interest in their products. When the level of differentiation between products is high, increases in advertising have no effect on observed prices. However, when the level of differentiation between products is moderate, increases in advertising tend to drive up prices. Finally, when the level of differentiation is low, the author shows that higher advertising leads to lower prices and profits. The modelling framework of this paper also provides an opportunity to examine the alleged anti-competitive effects of advertisng by evaluating the impact of higher advertising on total welfare. Holding the number of firms and the differentiation between firms constant, the author evaluates the effect of a reduction in the cost of advertising on total welfare (reductions in the cost of advertisng invariably lead to higher advertising). Not surprisingly, when higher advertising leads to either decreases in market prices or no price changes, total welfare increases. However, he finds that total welfare also increases in coditions where higher advertising leads to higher prices. This highlights the risk of reaching conclusions about the anti-competitive effects of high advertising based solely on an observed relationship between advertising and pricing.

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en

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application/pdf

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http://flora.insead.edu/fichiersti_wp/inseadwp2000/2000-05.pdf

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Copyright INSEAD. All rights reserved