Issues in Advertising: The Economics of Persuasion

By David G. Tuerck | Go to book overview

amortization becomes more difficult the smaller the expected market share of any individual brand and the higher the fixed costs of brand introduction. Brand proliferation reduces the former and heavy advertising raises the latter. That some firms will drop out and that other firms will not replace them is not surprising, nor are our statistical results.

In fact, the model is a plausible explanation for Joe Bain's lament:19

We are at loss to explain, for example, in terms of the preced
ing argument [i.e. the expectation of substantial selling outlays
for prestige, complex, or durable goods], the very high level
of selling costs that persists in the soap industry.

Our data show that the soap firms, for each of the time periods examined, had the largest or second largest value for the "new products per firm" variable. It is clear that any public policy concerned with intense oligopolistic advertisers should start with those factors that promote advertising. Brand proliferation looks like a good place to start.


Appendix A

Schmalensee's model starts with the profit function:
π = P Q (A, A + ̅,P) - C[Q(A,A + ̅,P) - AT
where P = price, C = cost, Q = quantity, A = "number of advertising messages . . . purchased by the firm at a constant cost of T per message," and A + ̅ = "number of advertising messages purchased by competitors."

The first order condition is:

.

The term (dA + ̅/dA) indicates the reaction expected from one's competitors if advertising is increased. Multiplying this expression by A + ̅/PQ, the second expression in the second parentheses by A + ̅/A and setting T = 1, we obtain:


E meaning elasticity, and the expression (EA + EA + ̅ Econj A) measuring net advertising elasticity of demand.

Therefore, A/PQ depends upon the price-cost margin and the elasticities of Q with respect to A and A + ̅, and the reaction of competitors. Assuming CQ, long-run marginal cost, is constant, it follows that when P rises, so does A/PQ. Interpreting P - CQ/P as the Lerner index of monopoly, it follows that profitability rises with P and therefore A/PQ rises with profitability.

____________________
19
Bain, Industrial Organization, p. 460.

-262-

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Issues in Advertising: The Economics of Persuasion
Table of contents

Table of contents

  • Title Page iii
  • Major Contributors v
  • Contents ix
  • Introduction 1
  • Acknowledgments 11
  • Part One Issues in Regulation 13
  • Advertising and Legal Theory 15
  • Advertising Regulation and the Consumer Movement 27
  • Commentaries 45
  • Part Two Advertising and the Firm 69
  • Towards a Theory of the Economics of Advertising 71
  • Introduction 71
  • Optimal Advertising: An Intra-Industry Approach 91
  • Conclusion 111
  • Technical Appendix 112
  • Commentaries 115
  • Part Three Advertising as Information 131
  • Advertising as Information Once More 133
  • Appendix A: Derivation of the Relationship Between a and P 156
  • Appendix B: Data Sources 158
  • Advertising, Information, and Product Differentiation 184
  • Commentaries 193
  • Four Part Advertising, Concentration, and Profits 215
  • Advertising Intensity and Industrial Concentration- an Empirical Inquiry, 1947-1967 217
  • Conclusions 249
  • Advertising and Oligopoly: Correlations in Search of Understanding 253
  • Appendix A 262
  • Appendix B 263
  • Commentaries 267
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