Table of Contents

Lecture 1:...........................................................................................................................1
George Bittlingmayer - Advertising:..............................................................................................1
Scope:.............................................................................................................................................................1
Economic function:.........................................................................................................................................2
Chapter 2.1 - Demand and consumer surplus:..............................................................................4
Deloitte, The economic contribution of advertising in Europe:.....................................................7
Amy Gallo: A refresher on price elasticity:...................................................................................8
Five stages of elasticity:..................................................................................................................................9
Lecture 1:

George Bittlingmayer - Advertising:

Economic analysis of advertising first started in 1930s and 1940s. Critics stated that
advertising was a monopolistic, wasteful practice.

Other defended advertising, stating that it promotes competition and lowers cost of
providing information to consumers.

Scope:

Measured as a percentage of GDP, the expenditure on advertising has stayed somewhat

constant since 1920.

2002 expenditure distribution:

Newspaper: 19%
Magazines: 5%
Broadcast and cable TV: 23%
Radio: 8%
Direct mail: 19%
Yellow pages, billboards etc: 27%

In 2002, internet ads, accounted for only 2% of total ads spending.

Advertising expenditures (BN $)

Agg. Expenditure has stayed much the same, but the dispersion of spending has changed.
Consumable, every-day, and necessity items are heavily advertised. This also goes for soft-
drinks cereal and beer.

Also, products that are heavily marketed in one geographic area, is likely also to be
marketed in other geographical areas.

Automakers spends on average 1-2% of sales on advertising. (Products are heavily

promoted in showrooms, and at events).

Economic function:

Self-serve checkout stores was made available with consumer knowledge and the creation
of strong brands, enabling consumers to not need so much help when shopping.

Ads-sales ratio: top 20 industries: 2003.

New introduced products are often marketed more than established ones. Products where
consumers constantly change or are somewhat indifferent will also often be heavily
advertised.

Non-informative / image ads:

Customers often desire a certain image or lifestyle associated with products such as beer,
cars, and cell phones. Vendors bundle the desired image with the physical product to cater
to these customer preferences. However, some customers may not be willing to pay for the
image and prefer a cheaper alternative. In response, manufacturers may produce both a
high-priced, heavily advertised version of the product and a lower-priced unadvertised
house brand or generic product.

Marketers generally agree that ads can be deceptive. Marketing can however also help in
limit deception and ensure good quality products. A heavily marketed brand will suffer
greatly from poor reviews and will basically be throwing money out the window (Marketing
initiatives).

Does advertising create barriers to entry?

Correlation between advertising intensity and industry concentration almost non-existent.

High levels of advertising is often associated with unstable market shares, which fits the idea
that marketing promotes competition, not monopoly.

Marketing depreciation = the rate at which advertisements lose their effect.

Same product is likely to be more expensive in areas where advertisement is prohibited. It is

however many times the same, in areas where only price-ads are prohibited.

Chapter 2.1 - Demand and consumer surplus:

Consumer surplus = willingness to buy - price paid.

If we are willing to buy a single French fry for 2 cents but only pay 1 cent, out consumer
surplus is:

Consumer surplus :2cent −1cent=1cent

Consumption often measured in (units per period of time).

We also know that consumer value generally decrease with the number of product
obtained/eaten, and will often reach zero at some point.
We call this feature: Diminishing marginal value.

“Value of last unit declines as number consumed increase”.

Quantity = q
Marginal value = v(q)

The demand curve shows this relationship. Where an increase in q, offers a lower Marginal
value.

Demand = refers to the demand curve

Quantity demanded = refers to a specific point of the curve.

We only want products when v(q) > p.

If x ( p ) = quantity bought at price (p).

Then:

v( x ( p ) ) = p.

Marginal value curve: u(q) for utility(quantity demanded).

If we pay u(q) for q, we are indifferent to receiving nothing and paying nothing.

New consumer surplus equation: CS=u ( q )− pq

To obtain maximal benefit, consumer choose q to maximize u(q) - pq. When CS is
maximized, the derivative is 0. Thus, CS must satisfy:

0=ddq ( u ( q )− pq ) =u ( q )− p
'
2.1.1
Meaning, v ( q )=u '( q)

Marginal value, is the derivative of total value.

We can generate a graph of CS using the following identity:

Expression states that consumer surplus can be shown as the area below the demand curve
and above the price.

CS = consumer gains from trade, the value of consumption to the consumer net of the price
paid.

CS can also be expressed using the demand curve. Integrating from the price up to where
demand curve intersects with price axis. X(p) is demand, we get:

Increases in demand are shown as movements in the entire demand curve. (up to the right)
Decrease (down to the left).

Inferior goods = Goods which people substitute away from, when their income rise.

Normal goods = Goods for which increases in income, also increase demand for that good.

Compliment goods = A good for which consumption of that good, increase the value of the
good which it compliments. (Use of computers increase the value of printers).

Substitute goods = A good where consumption of that good, lowers consumption/value of

the substitutable good. (Coca cola / Pepsi)
Deloitte, The economic contribution of advertising in Europe:

Economic model to determine economy-wide impacts of advertising. Found that advertising

in Europe has 7X impact on wider economy.

Meaning, on average 1€ spend on advertising, generates 7€ for the economy.

Advertising contributes to wider economic growth through its ability to support

competitiveness.

It provides information to consumers, helping to a more transparent buying process.

Drives innovation through businesses being incentivized to differentiate

Advertising provides about 6 million EU jobs. (2.6% of total employment)

 Directly employed to advertising (16% of total advertising-related jobs)

Rejects in-house advertising production.

 Media and online business jobs created by advertising (10% of total advertising-
related jobs).

Described as “quality jobs”. More security, and higher pay than average.

 Wider-economy jobs created from advertising. (Sales, supporting jobs, and

advertising-stimulated jobs). (74% of total advertising-related jobs).

Ads… provide personal and social benefits (funding/part-funding media services.) = People
can enjoy them for free or cheaper.

If advertising was not a thing, media, social media, streaming services, news-outlets etc.
would by and large be more expensive, or less extensive in reach. Advertising thus results in
better entertainment and informative content.
Amy Gallo: A refresher on price elasticity:

Some products can have very immediate and dramatic responses to price changes. Other
might not respond in the same way.

Product that responds a lot to changes in price can usually be characterized as nice-to-have,
non-essential, or that it has many substitutes.

∆q%
Price elasticity of demand=
∆p%

q=quantity demanded
p= price
∆=change

New−Old
∆=
Old

Positive/negative disregarded (usually). We take the absolute value of both q and p, as it is

not of great importance whether outcome is positive or negative.

The higher the result, the more sensitive customers are to changes in price.

Five stages of elasticity:

Perfectly elastic:

A very small change in price leads to very large change in quantity demanded.

(Pure commodities, no brands, no product differentiation, no meaningful attachment to

products).

Relatively elastic:

Small changes in price cause large changes in quantity demanded.

(Where, price elasticity of demand > 1).

Consumables (plain clothes like white/black socks)

Unit elasticity:

Any change in price is matched by equal change in quantity demanded.

Price elasticity of demand = 1

Relatively inelastic:

Large change in price leads to small change in demand.

Price elasticity of demand < 1

(Gasoline, products with stronger brands)

Perfect inelastic:

Quantity demanded does not change when price change.

Consumers absolutely need this. (Monopoly situations).

Price elasticity of demand, will be approaching 0

It is important that marketers identify what category their product fall into. It is not as
important to know the exact numerical figure as knowing the category.

Price elasticity is a very important metric to use by managers and marketers as price
elasticity is a way to see how good they are at delivering unique and sustainable value-
solutions to customers.

Marketers ultimately want their products to be as inelastic as possible. They can do this by
creating a differentiated and meaningful product.

Price elasticity is also not a static measure. It can fluctuate with initiatives of competition,
economic situation, and income-level of consumers.

Also, we cannot measure price elasticity until we have made a change in prices. Actually,
you would, in order to have the exact price elasticity measure, need to change prices many
times to see what demand is at each price-point. This is not what companies do in practice.
They are more likely to send questionaries and run focus groups.

Price sensitivity regards what the optimal price-range of a product is, price elasticity regards
the consumer willingness to buy our product at different price points.

Questionaries are fine, but what people say they would do, and what people actually do are
often not equal.
Lecture 2:

Bagwell 2.2 - The persuasive view:

Advertising may have important anti-competitive consequences. The persuasive view exerts
that advertising may have an entry-deterrence effect.

Advertising can create brand loyalty

Brand loyalty = entry barrier through established firms charging brand-premiums

Customer can be influenced via advertising to prefer one product over another, simply as a
result of the superior portrayal of their products.

Brathwaite (1928) views advertising as a selling cost. With the purpose of re-arranging
customers values so they are persuaded to value the advertised product over others.

“Advertisings effect is to induce consumers to purchase a wrong quantity of goods they are
unadopted to at premium prices due to advertising.”

Advertising can however also induce scale-effect, causing prices to fall.

Consumer surplus gain as result of lower prices marked as “G”.

Consumer surplus loss as result of wrong quantity demanded, marked as “L”.

If quantity demanded increase a lot and price reduction is small, L > G.

Entry deterrence effect revisited:

“By advertising, established firm creates reputation for its brand. New entrants can only
succeed only by developing a reputation for themselves.

They may even have higher expenses than the well-established firm, in doing so.

This can cause “reputational monopolies” which would also be an entry-deterring factor.

Reputation can however also offer benefits to customers, as manufacturers will have a
quality to live up to. Manufacturers are unlikely to risk this as they have used a lot of money
and time on building their reputation.

Quality effect is modest due to:

 1) Inferior goods sometimes gets reputations created even when they have short-lived
life-spans.

2) Consumers are not always the best at judging quality.

3) Quality guarantee is somewhat redundant as manufacturers already implicitly offers

this.

Brathwaite states that in total, the benefits received from reputation, is not enough to
offset the negative impact from advertising on the marketplace.

Kaldor (1950) further develops the persuasive view.

He imagines the direct and indirect effects from advertising on society.

Manufacturers domination:
Kaldor established this new type of organizational structure based on british advertising in
late 19th century.

It is when manufacturers use advertising to establish brand names and position them in
consumer consciousness.

The text discusses the role of advertising in creating product differentiation and its impact
on profitability and market competition. It begins by referring to the work of Bain in 1956,
who argued that advertising can contribute to establishing a preference for established
products over new entrants in consumer-goods industries. This advertising-induced product
differentiation can act as a barrier to entry and allow established firms to set higher prices
and earn greater profits. However, Bain's analysis has limitations, as it does not explain the
process through which advertising creates preference and relies on qualitative
classifications of industries.

Comanor and Wilson's work in 1967 and 1974 addresses some of the limitations of Bain's
analysis. They propose that advertising-induced product differentiation can create entry
barriers by increasing costs for new entrants compared to established firms. New entrants
face higher market-penetration costs as they need to persuade consumers to switch from
established products to unfamiliar ones. Comanor and Wilson also address the empirical
limitations of Bain's analysis by using quantitative data and regression analysis. They find a
positive relationship between profitability and advertising intensity, suggesting that
advertising contributes to profitability and serves as a barrier to new competition.

However, the endogeneity of advertising is a concern in interpreting the results. If firms

reinvest a percentage of their profits in advertising, the relationship between advertising
and profitability may be bidirectional. Comanor and Wilson address this concern by
extending their analysis to include equations that account for the influence of profit margins
on advertising intensity. They find that advertising continues to affect profitability and
provide empirical evidence of advertising scale economies.

Despite these advancements, Comanor and Wilson's work has limitations. They do not fully
explain how advertising interacts with consumers' experiences to reinforce established
firms' advantage, and profitability may be influenced by underlying product and market
characteristics rather than advertising alone. The endogeneity concern calls for
simultaneous equation methods, but identifying structural equations in an inter-industry
study is challenging due to endogenous variables. Measurement concerns also arise
regarding the treatment of advertising as an expense versus intangible capital. Furthermore,
inter-industry studies may overlook industry-specific relationships and features related to
advertising media mix.

Overall, the text highlights the role of advertising in creating product differentiation and its
effects on profitability and competition. It acknowledges the contributions and limitations of
earlier studies by Bain, Comanor, and Wilson, setting the stage for further research in the
field.

Von der Fehr & Stevik, Persuasive advertising and product differentiation:

Part 1: Write notes: (ChatGPT)

Part 2: Three ways in which advertising may affect preferences

Hotelling’s line model, consumers uniformly distributed along line segment of unit length.

x ∈[0,1]

Then x = number of consumers in interval [0, x]

Each consumer want one good.

Two symmetric firms exist, supplying differentiated goods.

Firm 0 products located at 0

Firm 1 products located at 1

Willingness to pay for 0 & 1 are:

0
U x =s−t (x ,θ)
U 1x =s−t ( 1−x ,θ )
Position of x can be interpreted as customers optimal product variety.
S is the willingness to pay for that variety.

Loss in surplus is increasing in the degree of (inherent) product differentiation, θ .

We can assume the whole market is covered by the two firms, consumers can thus be
divided into those who buy from firm 0 and firm 1.

Marginal consumer “x*” = Someone indifferent between two firms. Found by solving
equation:

Quantity demand from firm 0: y 0=¿ x*

Quantity demand from firm 1: y 1=¿ 1 - x*

For later we can note that:

Profit are given by:

I I i= pi y i−ai , i=0 , 1.