(Part B)
by
Charles Lamson
 |
Product Differentiation, Advertising, and Social Welfare
Monopolistically competitive firms achieve whatever degree of market power they command through product differentiation. To be chosen over competitors, products must have distinct positive identities in consumers' minds. This differentiation is often accomplished through advertising.
The United States is the largest advertising market in the world, with the ad spending amounting to 253.6 billion U.S. dollars In 2020. Looking at breakdowns of expenditures by medium, between 2019 to 2023, approximately 123 billion U.S. dollars are directed toward Internet ads in 2019, which is estimated to increase even further in 2023. This was followed by nearly 71 billion US Dollars spent on ads on TV in 2019 and is expected to amount to approximately the same in 2023 (Guttman, Sep 28, 2020; statista.com).
The effects of product differentiation, in general, and advertising, in particular, on the allocation of resources have been hotly debated for years. Advocates claim that these forces give the market system its vitality and power. Critics argue that they cause waste and inefficiency. Before we proceed to the models of monopolistic competition and oligopoly, let us look at this debate.
The Case for Product Differentiation and Advertising The big advantage of product competition is that it provides us with the variety inherent in a steady stream of new products while ensuring the quality of those products. A modern economy can satisfy a tremendous variety of tastes and preferences. Human wants are infinite in their variety.
Spirited competition with differentiated products is the only way to satisfy all of us. Business firms engage in constant market research to satisfy these wants. What do consumers want? What colors? What cuts? What sizes? The only firms that succeed are the ones that answer these questions correctly and thereby satisfy an existing demand.
The products that satisfy a real demand survive. The market shows no mercy to products no one wants. They sit on store shelves, are sold at heavily discounted prices or not at all, and eventually disappear: Firms making products that do not sell go out of business, the victims of an economic Darwinism in which only the products that can thrive in a competitive environment survive.
The standard of living rises when the technology of production improves---that is, when we learn to produce more with fewer resources. The standard of living also rises when we have product innovation, when new and better products come on the market.
Variety is also important to us psychologically. The astonishing range of products available exists not just because your tastes differ from mine. Human beings get bored easily we grow tired of things, and diminishing marginal utility sets in [The law of diminishing marginal utility states that, all else equal, as consumption increases, the marginal utility derived from each additional unit declines. Marginal utility is derived as the change in utility as an additional unit is consumed. Utility is an economic term used to represent satisfaction or happiness (investopedia.com)]. To satisfy many people with different preferences that change over time, the market must be able to respond with new products.
Proponents of product differentiation also argue that it leads to efficiency. If any product is of higher quality than my competition's product we'll sell more and my firm will do better. If I can produce something of high quality more cheaply that is, more efficiently then my competition can, I will force them to do likewise or go out of business. Creating a brand name through advertising also helps to ensure quality. Firms that have spent millions to establish a brand name or reputation for quality have something of value to protect.
For product differentiation to be successful, consumers must know about product quality and availability. In perfect competition [Perfect competition is an ideal type of market structure where all producers and consumers have full symmetric information, no transaction costs, where there are a large number of producers and consumers competing with one another. Perfect competition is theoretically the opposite of a monopolistic market (investopedia.com)], where all products are alike, we assume that customers have perfect information; without it, the market fails to produce an efficient allocation of resources. Complete information is even more important when we allow for product differentiation. Consumers get this information through advertising, at least in part. The basic function of advertising, according to its proponents, is to assist consumers in making informed, rational choices.
Supporters of product differentiation and advertising also claim that these techniques promote competition. New products can compete with old, established brands only if they can get their messages through to consumers. When consumers are informed about a wide variety of potential substitutes, they can more effectively resist the power of monopolies.
The advocates of spirited competition believe that differentiated products and advertising give the market system its vitality and are the basis of its power. They are the only ways to begin to satisfy the enormous range of tastes and preferences in a modern economy. Product differentiation also helps to ensure high-quality and efficient production, and advertising provides consumers with valuable information on product availability, quality, and price that they need to make efficient choices in the marketplace.
The Case Against Product Differentiation and Advertising Product differentiation and advertising waist society's scarce resources, argue critics. They say enormous sums of money are spent to create minute, meaningless differences among products.
Drugs, both prescription and non-prescription, are an example. Companies spend millions of dollars to "hype" brand-name drugs that contain exactly the same compounds as those available under their generic names. The antibiotics erythromycin and erythrocin have the same ingredients, yet the latter is half as expensive. Aspirin is aspirin, yet we pay twice the price for an advertised brand, because the manufacturer has convinced us that there is a tangible or intangible difference.
Do we really need 50 different kinds of soup, all of whose prices are inflated substantially by the cost of advertising? For a firm producing a differentiated product, advertising is part of the everyday cost of doing business; its price is built into the average cost curve and thus into the price of the product in the short run and the long run. Thus, consumers pay to finance advertising.
In a way, advertising and product differentiation turn the market system completely around. An economic system is supposed to meet the needs and satisfy the desires of members of society. Advertising is intended to change people's preferences and to create wants that otherwise would not have existed. From the advertiser's viewpoint, people exist to satisfy the needs of the economy.
Critics also argue that the information content of advertising is minimal at best and deliberately deceptive at worst. It is meant to change our minds, to persuade us, and to create brand "images." To the extent that no information is conveyed, critics argue, advertising creates no real value, and thus a substantial portion of the resources that we devote to advertising is wasted.
Competitive advertising can also easily turn into unproductive warfare. Suppose there are five firms in an industry and one firm begins to advertise heavily. To survive, the others respond in kind. If one firm drops out of the race, it will certainly lose out. Advertising of this sort may not increase demand for the product or improve profitability for the industry. Instead, it is often a "zero-sum game"---a game in which the sum of the gains equals the sum of the losses.
Finally, some argue that advertising by its very nature imposes a cost on society. We are continuously bombarded by bothersome jingles and obtrusive images. When driving home from work, we pass 50 billboards and listen 215 minutes of news and 30 minutes of advertising on the radio. When we get home, we throw away 10 pieces of unsolicited junk mail, glance at a magazine containing 50 pages of writing and 75 pages of advertisements, and perhaps watch a television show that is interrupted every 5 minutes for a "message."
The bottom line, critics of product differentiation and advertising argue, is waste and inefficiency. Enormous sums are spent to create minute, meaningless, and possibly non-existent differences among products. Advertising raises the cost of products and frequently contains very little information. Often, it is merely an annoyance. Product differentiation and advertising have turned the system upside down: People exist to satisfy the needs of the economy, not vice versa. Advertising can lead to unproductive warfare and may serve as a barrier to entry, thus reducing real competition.
No Right Answer Many questions have no right answers. There are strong arguments on both sides of the advertising debate, and even the empirical evidence leads to conflicting conclusions. Some studies show that advertising leads to concentration and positive of profits; others, that advertising improves the functioning of the market.
*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 283-286*
No comments:
Post a Comment