Archive for May, 2012

Have you ever thought why wheat farmers don’t advertise their products on TV as the mobile phone network operators such as Vodafone and Orange or car dealers do? The fact is that because advertising is useful only in industries in which companies have at least some market power (as it is in monopoly, oligopoly and monopolistic competititon in economic terms). Market power can be defined as the ability of a producer to raise prices.

Certainly, the main aim of advertising is to get people to buy more of a seller’s product at the going price. So only a company that has some market power, and therefore can charge a price that is above marginal cost, can gain from advertising. After this logic, it is not hard to see why many companies spend so much money on it. However, the main question which comes to the mind is why advertising works even though the money spent on advertising is often regarded as a waste of resources by the society. Although many advertising creates a puzzle in the minds, much of it is straightforward by informing potential buyers clearly about what sellers are offering. So companies believe that money spent on such promotions increase their sales and they would be in a bad situation if they stopped advertising when their competitors continue to do it.

But what information is given when an actress or sportsman acclaims the virtues of a car or if David Beckham wears H&M brand of boxers? Surely, nobody believes that the actress or sportsman is an expert on car or David Beckham really buys his boxers from H&M. Why are consumers still influenced by ads that do not accord with the reality and not provide any information about the product? One answer is that consumers are not as rational as economists suppose. Their judgements, or even tastes, can be influenced by many irrelevant things such as which celebrity has been hired by the company to endorse its product.

On the other hand, another answer shows that consumer response to advertising is not entirely irrational since ads can serve as indirect signals about the product and company. For example, if you need furniture removals and turn to the Yellow Pages including a lot of small listings and several large display ads, you most probably rationally call one of the firms with a big display ad. Because the big ad probably connotes that it’s a successful company — otherwise, it wouldn’t spend so much money for the larger ad.

Let’s apply the same principle to the ads with celebrities. You don’t really believe that David Beckham prefers H&M boxers to all other more expensive brands; however the fact that the company is willing and able to pay David Beckham tells you that it is a major company and most likely to stand behind its product. According to this reasoning, an expensive advertisement is a venue for the company to put the quality of its products in the eyes of consumers.

After all, it won’t be truism to say that ads only work by manipulating weak-minded consumers especially if we consider the huge amount of spending on advertising. Seemingly, it is an economically productive activity for many companies.