economics of management strategy bee3027 lecture 3 15/02/2008
Post on 19-Dec-2015
215 views
TRANSCRIPT
Recap
• Last week we looked at:– Property-rights motivation for existence of firms;
– Team production;
– Compensation schemes;
– Coordination problem in production.
This week
• We will look at:
• Strategic interaction in oligopolies:– The role of managers and strategic delegation.
• Advertising.
Advertising
• Advertising is an integral part of our lives.
• It is also one of the largest industries:– Global spending on advertising in 2005: $400bn
• Economists see advertising as a means to transmit information about a good or service.
• However, there are 2 key aspects to it:– Information receivers don’t pay for information;– Information is transmitted by the seller.
Advertising
• Advertising expenditure is usually measured as the ratio of adv expenditure to sales.
• This ratio varies drastically across industries:
• We will look at advertising from two different perspectives:– Persuasive advertising;– Informative advertising.
Persuasive Advertising
• Models of persuasive advertising assume that advertising enhances consumer preferences for a given product.
• Hence, higher expenditures on advertising result in increased demand for a product.
• Typically you’d think of the effect of advertising as a rightward shift in the demand curve.
Persuasive Advertising
• Firm must balance out the effects on demand of a shift in demand due to advertising expenditures and the impact of a change in price.
• The balance is found when
• Markets sensitive to advertising will have higher advertising-to-sales ratios
PQ
AQ
PQ
A
,
,
Informative advertising
• In the real world, there are a number of different products which cater to our needs.
• However, it is difficult to know all the products out there and make an informed choice.
• Advertising can be seen as a means to inform consumers of the existence of a product.
• In this sense, it may be socially productive to engage in advertising activities.
Informative advertising
• Consider the case of a single consumer, in a market with a single good. – The price of this good is fixed at p.– The benefit the consumer gains from the good is m.
• Hence, the consumer’s utility function is:m – p if he purchases the good;
0 otherwise
Informative advertising
• There are two firms selling this product.– There are zero production costs
• Firms can only use advertising as a tool to boost sales.– Advertising has a cost equal to A
• Therefore, the consumer may receive a total of 0, 1 or 2 ads from the two companies.
Informative advertising
• If the consumer receives no ads, he will not buy the product.
• If the consumer only receives on ad, he will buy the product from that company.
• If the consumer receives both ads, he will pay p/2 to both firms.– This is equivalent to flipping a coin to determine
which firm to buy the product from.
Informative advertising
• Therefore, the payoff to firm i is:p – A if only firm i’s ad is received;
p/2 – A if both firms’ ads are received;
– A if firm i sends an ad but consumer does not receive it;
0 if firm i does not advertise
• The fact that firms create ads does not imply consumers will see them.
Informative advertising
• The probability that the consumer will see the ad is the same for both firms and is equal to δ, where 0 < δ < 1.
• So, the expected profit for firm i is:δ(1- δ)(p-A) + δ²(p/2-A) – (1- δ)A if 2 firms advertise;
δ(p-A) – (1-δ)A if only firm i advertises;
0 if firm i does not advertise.
Informative advertising
• What is the social optimal level of advertising?– The social planner wants to maximise consumer
surplus and total profit
• Expected welfare is:δ(2- δ )m – 2A if two firms advertise;
Δm – A if one firm advertises;
0 if no firm advertises
Informative advertising
• Suppose that p would be set to its maximum level, such that consumer surplus is zero– i.e. p = m– This way, welfare = profits and our analysis is made
much simpler!
• It is therefore socially optimal for two firms to advertise if:
δ(2- δ )p – 2A > δp – A p/A > 1/[δ(1- δ)]
Informative advertising
• So, there are combinations of p/A and δ in which:– It is profitable for each firm to advertise;– But where it is socially inefficient to do so.
Informative or persuasive?
• So far, we’ve covered two different approaches to advertising.
• These models assume that either:– Consumers are aware of the product, but need “convincing”; or– Consumers are unaware of the product, but would buy it once
they know about it.
• In reality, some consumers will not be informed, while others will.
• In the latter case, it is likely some consumers will prefer one product over others.
Targeted advertising
• The bottom line is that firms will be unable to successfully reach the entire set of consumers.
• Firms must instead target a subset of consumers for which their advertising appeals.– It is almost impossible to identify product attributes
which are universally appealing;– Advertising is costly, hence there will diminishing
returns to scale;– Having a differentiated product gives firms market
power, thus implicitly segmenting their demand.
Targeted advertising
• Consider 2 firms, 1 and 2 producing differentiated brands of the same product, brand 1 and brand 2.
• There are two types of buyers:– N inexperienced consumers;– E experienced consumers.
• E is divided into:– θ consumers who prefer brand 1;– (1-θ) consumers who prefer brand 2.
Targeted advertising
• In this model, a firm may either use:– Persuasive advertising, P, or– Informative advertising, I.
• P only affects inexperienced consumers. So if firm 1 chooses P:– If firm 2 chooses I, firm 1 gets N consumers;– If firm 1 also chooses P, both firms get N/2
consumers.
• I only affects experienced consumers. – If firm 1 chooses I, it gets θE consumers;– If firm 2 chooses I, it gets (1- θ)E consumers.
Targeted advertising
• Any of the 4 outcomes can be an equilibrium of this game depending on certain market conditions.
• (P,P) is an equilibrium (i.e. firms only target inexperienced consumers) if:– N > E;
–
• (I,I) is an equilibrium (i.e. firms only target inexperienced consumers) if – E > 2N;
–
E
N
E
N
221
E
N
E
N 1
Targeted Advertising
• If brand 1 is unpopular among experienced users, firm 1 will use persuasive advertising and firm 2 will use informative advertising.
• (P,I) is an equilibrium if:
– }{2
1,minE
N
E
N