Essay on Advertising and Economic Welfare
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Last updated 4 Feb 2019
Here is a suggested answer to this question: "Evaluate the possible economic and social impact of high levels of advertising spending in an oligopolistic market."
Traditional and digital advertising are common features of non-price competition between businesses in an oligopolistic market. In part this is because of the interdependent nature of decision-making in this market structure. Firms have to consider what their rivals are choosing to do, and game theory suggests that the Nash equilibrium might be for firms to spend heavily on advertising if rivals are doing likewise to prevent a loss of market share, sales revenue and, ultimately, operating profits. But to what extent is a high level of advertising beneficial for consumers and society as a whole?
One justification for advertising is that it provides useful information to consumers that helps them to make a more fully-informed choice. Many complex goods and services such as pensions and pharmaceutical products require consumers to know about the costs and benefits of consumption both in the immediate and longer-term. Informative marketing can help overcome market failures that result from persistent information gaps. They give consumers better awareness and, by driving increased demand and higher levels of output, they can also help businesses achieve internal economies of scale leading to lower unit costs and reduced prices.
However, much advertising is persuasive rather than informative and it can often contain false and misleading claims about the effectiveness of a product. It seeks to manipulate our tastes and preferences and can distort the working of the price mechanism by diluting consumer sovereignty. In an oligopoly, effective advertising is a barrier to entry which makes it harder for new firms to enter the industry leading to a reduction in contestability and higher prices for consumers in the long run. Advertising raises costs of production which might be passed on to consumers through higher prices which leads to deadweight losses of economic welfare.
A second argument defending high levels of advertising spending is that marketing is in its own right a creative industry that employs hundreds of thousands of people and which makes a sizeable contribution to GDP and also to a nation’s trade balance. According to recent research, the UK advertising industry generates a total of £120 billion to GDP in the UK each year and supports 1,000,000 jobs. The UK is also one of the leading exporters of creative services in the global economy, advertising is an area of comparative advantage and without it, unemployment would be higher. With less advertising, revenues and jobs in other industries would also be at threat - for example in newspapers, sporting and cultural events.
A counter argument to this is that persuasive advertising can contribute to a culture of over-consumption and under-saving leading to higher levels of household debt which is then a barrier to economic growth and a cause of higher inequality. Lower income households in particular who fall into debt are vulnerable to taking out unsecured loans at very high rates of interest. The level of outstanding debt on credit cards in the UK has now reached record levels and advertising itself may have been a factor - consider for example the numerous adverts on television for pay-day loans and debt consolidation services.
The evidence is that the highest advertising spenders in the UK all operate in oligopolistic markets - good examples include BT, Sky, Proctor and Gamble and Amazon. These firms are highly profitable which suggests that advertising works mainly in the interests of producers rather than consumers. My overall view is that whilst the majority of advertising probably has a benign effect on consumer welfare, marketing that makes effective ploys to tempt to consumers into making ill-advised and unaffordable purchases can cause long term damage. A good example is the advertising of funeral insurance and airline flight insurance products which tap into the behavioural bias of loss aversion and often cause people to buy items that they really do not need. The profit-maximising level of advertising spending is probably higher than society would want.