Advertising and Its Effect on the Demand Curve
THE UNIVERSITY OF QUEENSLAND ECON7002 Markets in Action Advertising and its effect on the demand curve Markets in Action Advertising and its effect on the demand curve Advertisement has always been an important market strategy for firms to accomplish their goals. From cereal companies to airline companies, it is inevitable to go through the process of advertising. However, what purpose does advertising serve for consumers and suppliers in the market? In this report, it is to examine the relationship between advertising and the market demand curve.
Moreover, the impact that advertising brings toward the consumers and the company supplying the product or service. It is no doubt that peoples’ income is always limited relatively to peoples’ wants. Consumers therefore have to make choices among different products and services (P&S) to satisfy their unlimited wants with limited income. Firms take advantage of this issue by advertising the P&S they produce to increase their profits. There are two primary motives for companies to advertise their products and services.
The first motive is to shift the demand curve to the right, meaning an increase in market demand for a product/service. The second motive is to lower the elasticity of the demand curve, meaning the demand for a product/service is less affected when the price of that product/service changes (Sloman, Norris & Garratt 2010). There are a number of reasons that causes a demand curve to shift to the right. In the case of advertisement, changing the preferences and tastes of the consumers can have a significant effect on demand.
By enhancing the taste and preference of consumers, it draws new and inexperienced customers to purchase the product/service (Acharyya & Mukherjee 2003). Therefore, advertising brings a firm’s product/service to more people’s attention and increases the people’s desire for purchasing it. Advertisements can also eliminate the possible limitations in the knowledge of consumers and familiarize them with new information about the product/service. Consumers can not review the qualities and values for most products and services in the market until it is purchased, such as kitchen appliances or automobiles.
With providing information about the product/service by advertisements, the firm aims to influence the purchasing decision and raise the willingness to pay of the consumers (Erdem, Keane & Sun 2007). For example, SONY can change the consumer’s purchasing preference and taste by conducting a computer technology exhibition that displays the relevant technology information about the computers. Another example is McDonalds creating a television commercial about shaker fries to inform customers about this new product. Below is a figure illustration that shows the effect of advertising by a rightward shift in the demand curve.
With the supply curve unaffected, it can be seen that the quantity demanded increases from Q to Q’ when the demand curve shifts to the right. As for the price of the product/service, it increases from P to P’. Figure1. Effect of advertising by a rightward shift in the demand curve Price elasticity is the responsiveness of consumer demand when the price of the product/service rises or falls. Firms therefore use advertisements to affect consumers purchasing decisions by compelling people to buy their product/service over competitors. This means to make their product/service highly inelastic relatively compared to their competitor’s substitutes.
So what factors influence the price elasticity of demand? In this report, five determinants are examined. The first factor is the number and closeness of substitute product/service. For companies that have monopoly power such as oil and electricity, an advertising scheme is usually unnecessary as consumer demand are already consistent regardless of a change in price. On the other hand, firms that have competitors attempts to use advertising plans to create product differentiation. The second factor is the proportion of income spent on the product/service.
Product/service purchases which have a small portion to total expenditure tends to have a lower elasticity, since consumers has less difficulty with the extra expenditure when prices go up. For example, salt and pepper. The third factor is whether the product/service is a luxury or a necessity. Products/services which are necessary goods tend to be more inelastic as they are used to fulfill the basic needs of a consumer even if the prices go up. Whereas luxury goods are more elastic as purchases can be postponed to the future. For example, laundry detergent is a necessity and Tiffany & Co jewelry is a luxury.
The forth factor is whether or not the product/service is addictive. Products/services that are habit forming tend to be inelastic as they are required to satisfy the habit of the consumer. For example, cigarettes and alcohol beverages are addictive goods. The last but not the least factor is the amount of time consumers have to respond to a change in the price. With a longer time period, the elasticity of demand is more elastic as consumers have more time to adjust their purchasing habit (Welker 2010). In a competitive industry such as electronic products and clothing, the demand curves are most likely elastic.
Advertising attempts to make the demand curve of the product/service more inelastic by utilizing the first and third factor in the previous paragraph. Creating more product differentiation to their substitutes and making their products as a necessity. A major method of product differentiation is to instill consumers with brand loyalty. With brand loyal consumers, they are willing to purchase at higher price for the intangible effects of the product/service. Slogans and Logos are popular schemes to familiarize consumers with brand names and increase brand loyalty (Patti 1977).
For example, “Because you are worth it” by L’Oreal Cosmetics and “Buy it, sell it, love it” from eBay (Oak 2011). Advertisements can change the consumer’s relative evaluation of substitutes by leading them to believe that the substitute brands are inferior. For example, commercial battles between Apple and Blackberry. Nowadays, persuasive advertisements have reshaped the purchasing habit of consumers with culture and life background, leading consumers to think products/services are a necessary good such as cereals for breakfast (Acharyya & Mukherjee 2003).
Next page is a figure illustration that shows the effect of advertising by a decrease in elasticity in the demand curve. With the same price rise P to P’, it can be seen that the quantity demanded decreases by a larger amount from Q to Q1 when the demand curve is elastic (curve D). On the other hand, the more inelastic curve (curve D’) has a relatively smaller quantity decrease from Q to Q2. Figure2. Effect of advertising by a decrease in elasticity in the demand curve Figure3. Effect of advertising by a change in the demand curve With both a decrease in elasticity and a rightward shift in the demand curve, sales are increased from Q?
P to Q’? P’. This is due to firms can now charge a higher price in a less competitive environment. So how do companies advertise their products/services? Firms advertise advertisement through a number of mediums, including emails and mails such as Dominos pizza, magazines such as Marc Jacob, bulletin boards such as Billabong, Radio announcements such as AAMI, television ads such as Optus and Yellow pages etc. Companies spend a significant amount of capital and time to plan a strategy to persuade people to purchase products.
Some common strategy techniques includes celebrity testimonial, claiming that their products is desirable and consumed by many people, authority endorsements, slogan and logos etc (Gladen 2008). An advertising strategy of Apple is to gain brand loyalty of consumers while charging at a higher price. Apple posts new advertisements continuously on the internet with branding strategy that focuses on peoples’ emotion such as lifestyle, imagination, aspirations, passion and dreams. It also uses advertisements to show an indefinable “cool” element associated with every new innovation devices that they produce.
The will therefore inevitably be increased by bringing in new customers and increasing the desire of purchase. Another technique is to show that competitors such as Microsoft PCs and Blackberry phones are an inferior product. For example, Apple created the ad “Mac vs. PC (Deny or allow)” to indicate that it is worth paying higher price for a virus-free Mac then a Microsoft PC (Marketing minds, 2011). For cosmetic brand Cover Girl, one of their strategies is to create a slogan to facilitate brand recognition. This leads to product demand curve becoming more inelastic.
Almost all firms create a unique slogan to bolster and augment its business branding. Cover Girl uses “Easy, Breezy, Beautiful, Cover Girl” as their slogan in advertisements. Moreover, they use celebrity endorsements including Rihanna, Taylor Swift, Jennifer O’Nell and etc. as the face of their brand. Cover Girl also has a $100,000 US contact with America’s next top model every season (the most global popular modeling reality TV show). Celebrity enforcements work in a way that consumers identify themselves with the celebrity in the advertisements, and are mostly likely to increase demand in targeted consumers (Wikipedia, 2011).
Advertisements have both advantages and disadvantages towards the consumers and the company supplying the products/services. The advantages for consumers include alerting people to products/services that fulfills the niche requirements they have such as tastes, preference, lifestyle and etc. Moreover, consumers have better access to the product/service information and guidance. On the other hand, disadvantages include overstating the effectiveness of the product/service and mislead the consumers to make bad purchasing decisions.
It also creates dissatisfaction for some people as their income cannot afford the desired product. Advertising appeals can also affect people’s health by promoting alcohol and cigarettes. For companies that supplies the products and services, advantages include increasing the exposure and awareness of the new developed products/services to consumers. Increase sales and profit if advertising scheme is successful. The form of online advertising using YouTube and other video sharing websites decreases the costs of supply.
However, disadvantage includes spending excessive money on celebrity endorsements or on AFL half-time broadcast with no significant profit gains (Akrani 2010). Successful firms have a good understanding in who purchases their products, why consumers purchase their products and what advertising strategy to utilize to influence consumers purchasing decision. From this report, it can be seen that companies use a variety of advertisement plans to increase the demand of their products/services as well as to reduce the elasticity of the products/services.
By changing the demand curve with a rightward shift and with a steeper slope, the main goal that firms are trying to achieve is to increase the sales and profits. Some advertising strategies might induce disadvantages to consumers and suppliers, but with suppliers applying the most suitable strategy by research and evaluation, it is more likely that both parties will benefit from the advertising result. Reference Sloman, J, Norris, K & Garratt, D 2010, Principles of economics, 3rd edition, Pearson Australia, NSW Australia Acharyya, R & Mukherjee D 2003, ‘Advertisement and Markets’, Economic and political weekly, Vol. 8, No. 50, pp. 5236-5239 Erdem, T, Keane, MP & Sun, B 2008, ‘The impact of advertising on consumer price sensitivity in experience goods markets’, Quant market economics, Vo. 6, pp. 139-176 Patti, CH 1977, ‘Evaluating the role of advertising’, Journal of advertising, Vol. 6, No. 4, pp. 30-35 Welker, J 2010, The role of advertising in determining price elasticity of demand, viewed 27 Sep 2011, http://welkerswikinomics. com/blog/2010/10/04/im-proud-to-be-a-canadian-and- i-like-beer/ Oak, M 2011, Famous commercial slogans, viewed 27 Sep 2011, http://www. buzzle. com/ articles/famous-commercial-slogans. tml Gladen, NR 2011, Advertising and persuasive strategies, viewed 28 Sep 2011, http://naomi- rockler-gladen. suite101. com/advertising-persuasion-techniques-a52647 Marketing Minds 2010, Apple’s branding strategy, viewed 28 Sep 2011, http://www. marketing minds. com. au/branding/apple_branding_strategy. html Wikipedia 2011, Cover Girl, viewed 28 Sep 2011, http://en. wikipedia. org/wiki/CoverGirl Akrani, G 2010, Advertising-Advertising management features and benefits, viewed 29 Sep 2011, http://kalyan-city. blogspot. com/2010/07/5-ms-of-advertising-advertising. html
