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The Economic Impact of Advertising
by
Charles Lamson
Effect on the Value of Products
Why do most people prefer Coca-Cola to some other cola? Why do some people prefer Ambercrombie & Fitch khakis to some other unadvertised brand? Are the advertised products functionally better? Not necessarily, but in the mind of the consumer, advertising has given these brands added value.
In the mid-1960s, a famous psychologist named Ernest Dichter asserted that a product's image, created in part by advertising and promotion, is an inherent part of the product itself. Subsequent studies showed that while an ad may not address a product's quality directly, the positive image conveyed by advertising may imply quality. Moreover, by simply making the product better known, advertising can make the product more desirable to the consumer. In these ways, advertising adds value to the brand. That is why people pay more for Bufferin than an unadvertised brand displayed right next to it---even though all buffered aspirin, by law, is functionally the same.
Advertising also adds value to a brand by educating customers about new uses for a product. Kleenex was originally advertised as a makeup remover, later as a disposable handkerchief. AT&T first promoted the telephone as a necessity and later as a convenience.
One advantage of the free-market system is that consumers can chose the values they want in the products they buy. If, for example, low price is important, they can buy an inexpensive economy car. If status and luxury are important, they can buy a fancy sedan or racy sports car. Many of our wants are emotional, social, or psychological rather than functional. One way we communicate who we are (or want to be) is through the products we purchase and display. By associating the product with some desirable image, advertising offers people the opportunity to satisfy those psychic or symbolic wants and needs.
In terms of our economic framework, by adding value to products, advertising contributes to self-interest---for both the consumer and the advertiser. It also contributes to the number of sellers. That increases competition, which also serves the consumer's self-interest.
Effect on Prices
If advertising adds value to products, it follows that advertising also adds cost, right? And if companies stopped all that expensive advertising, products would cost less, right?
Wrong.
Some advertised products do cost more than unadvertised products, but the opposite is also true. Both, the Federal Trade Commission and the Supreme Court have ruled, that by encouraging competition, advertising has the effect of keeping prices down. That again serves the consumer's self-interest. And that is why professionals such as attorneys and physicians are now allowed to advertise.
Sweeping statements about advertising's positive or negative effect on prices are likely to be too simplistic. We can make some important points, though:
Effect on Competition
Some observers believe advertising actually restricts competition because small companies or industry newcomers cannot compete with the immense advertising budgets of large firms.
It is true that intense competition does tend to reduce the number of businesses in an industry. However, some of the firms eliminated by competition may be those that served customers least effectively. In other cases, competition is reduced because of mergers and acquisitions (big companies working in their own self-interest).
High costs may inhibit the entry of new competitors in industries that spend heavily on advertising. In some markets, the original brands probably benefit greatly from this barrier. However, the investments needed for plants, machinery, and labor are of far greater significance. These are typically the real barriers to entry, not advertising.
Advertising by big companies often has only a limited effect on small businesses because a single advertiser is rarely large enough to dominate the whole country. Regional oil companies, for example, compete very successfully with national oil companies on the local level. In fact, the freedom to advertise encourages more sellers to enter the market. And we have all seen nonadvertised store brands of food compete very effectively with nationally advertised brands on the same grocery shelves.
Effect on Consumer Demand
The question of advertising's effect on total consumer demand is extremely complex. Numerous studies show that promotional activity does affect aggregate consumption, but they disagree as to the extent. Many social and economic forces, including technological advances, the population's educational level, increases in population and income, and revolutionary changes in lifestyle, are more significant. For example, the demand for MP3 players, cellular phones and broadband Internet service expanded at a tremendous rate, thanks in part to advertising but more to favorable market conditions. At the same time, advertising has not reversed declining sales of such items as hats, fur coats, and manual typewriters.
Advertising can help get new products off the ground by giving more people more complete information, thereby stimulating primary demand---demand for the entire product class. In declining markets, when the only information people want is price information, advertising can influence selective demand---demand for a particular brand. But the only effect it will have on primary demand is to slow the rate of decline. In growing markets, advertisers generally compete for shares of that growth. In mature, static, or declining markets, they compete for each other's shares---conquest sales.
Effect on Consumer Choice
For manufacturers, the best way to beat the competition is to make their product different. For example, look at the long list of car models, sizes, colors, and features designed to attract different buyers. And grocery shelves may carry more than 100 different brands of breakfast cereals---something for everybody.
The freedom to advertise encourages businesses to create new brands and improve old ones. When one brand reaches market dominance, smaller brands may disappear for a time. But the moment a better product comes along and is advertised skillfully, the dominant brand loses out to the newer, better product. Once again, the freedom to advertise promotes the existence of more sellers, and that gives consumers wider choices.
Effect on the Business Cycle
The relationship between advertising and gross domestic product has long been debated. John Kenneth Galbraith, a perennial critic of advertising, concedes that by helping to maintain the flow of consumer demand (encouraging more buyers), advertising helps sustain employment and income. But he maintains that, despite declines in the value of the dollar, the U.S. trade deficit persists because advertising and marketing activities create consumer preference for certain foreign products.
Historically, when business cycles dip, companies cut advertising expenditures. That may help short-term profits, but studies prove that businesses that continue to invest in advertising during a recession are better able to protect, and sometimes build, market shares. However, no study has shown that if everybody just keeps advertising, the recessionary cycle will turn around. We conclude that when business cycles are up, advertising contributes to the increase. When business cycles are down, advertising may act as a stabilizing force by encouraging more buyers to buy.
The Abundance Principle: The Economic Impact of Advertising in Perspective
To individual businesses such as Abercrombie & Fitch, the local car dealer, and the convenience store on the corner, advertising pays back more than it costs. If advertising did not pay, no one would use it. And the various news and entertainment media that depend on advertising for financial support would go out of business.
Advertising costs less for the customer than most people think. The cost of a bottle of Coke includes about a penny for advertising. And the $20,000 price tag on a new car usually includes a manufacturer's advertising cost of less than $400.
To the economy as a whole, the importance of advertising may best be demonstrated by the abundance principle. This states that in an economy that produces more goods and services that can be consumed, advertising serves two important purposes: It keeps consumers informed of their alternatives (complete information), and it allows companies to compete more effectively for consumer dollars (self-interest). In North America alone, the U.S. and Canadian economies produce an enormous selection of products. Most supermarkets carry more than 30,000 different items. Each carmaker markets dozens of models. And many suppliers compete for the consumer dollar. This competition generally results in more and better products at similar or lower prices.
Advertising stimulates competition (many buyers and sellers). In countries where consumers have more income to spend after their physical needs are satisfied, advertising also stimulates innovation and new products. However, no amount of advertising can achieve long-term acceptance for products that do not meet consumer approval. Despite massive advertising expenditures, fewer than a dozen of the 50 best-known cars developed in the 20th century are still sold today.
Advertising stimulates a healthy economy. It also helps create financially healthy consumers who are more informed, better educated, and more demanding. As a result, consumers now demand that manufacturers be held accountable for their advertising. This has led to an unprecedented level of social criticism and legal regulation.
*SOURCE: CONTEMPORARY ADVERTISING, 25TH ANNIVERSARY ED., 2008, WILLIAM F. ARENS, MICHAEL F. WEIGOLD, CHRISTIAN ARENS, PGS. 58-62*
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