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2. AEM 4550: Economics of Advertising Prof. Jura Liaukonyte LECTURE 6: OTHER TYPES OF ADVERTISING

3. Lecture Plan  Persuaders  Informative view  Model and Examples  Signaling as Information  “Memory Jamming” view

4. Informative Advertising

5. Comparison  Higher advertising leads to higher demand for each consumer, which leads to higher prices. Persuasive/Complementary ModelInformative Model   Higher levels of advertising leads to more consumers but not a higher demand for each consumer, so prices are not affected by advertising levels.

6. Signaling as Information  For experience goods, advertising can also be used to signal quality.  If a company engages in an expensive ad campaign, you might infer that the good is high quality because only high quality firms could afford the campaign.  Price is can also be used as a signal of high quality.

7. Signaling as Information  Nelson, 1970 begins with a simple question:  How, exactly, does advertising provide information to consumers?  The informative content of advertising is clear, when the advertisement contains direct information as to the existence, location, function or price of a product.  But what about all of the advertising that does not contain direct information of this kind? Is it persuasive?  Nelson argues rather that such advertising still plays an informative role, although the role is indirect.

8. Signaling as Information  To develop this argument, Nelson (1970) makes a distinction between search and experience goods.  Recall, a search good is one whose quality can be determined prior to purchase (but perhaps after costly search),  The quality of an experience good can be evaluated only after consumption occurs.  Indirect information contained in advertising is especially important for experience goods.

9. Signaling as Information  3 reasons why advertising may provide indirect information about experience goods. 1. Signaling-efficiency effect.  The demand expansion that advertising induces is most valuable to efficient firms,  By advertising, a firm signals that it is efficient, which implies in turn that it offers good quality/good deal.

10. Signaling as Information 2. Match-products-to-buyers effect.  Consumers may have heterogeneous tastes, and it may be difficult to efficiently match products and buyers.  A seemingly uninformative ad can assist in this process, since a firm has the incentive to direct its advertising toward the consumers that value its product the most.

11. Signaling as Information 3. Repeat-business effect.  Ads may remind consumers of their previous experience with the product, and such recollections are of more value to sellers of high-quality goods.  Even new consumers may draw a positive association between advertising and quality, and advertising thus may signal quality.  Similar to “Memory Jamming” View

12. Signaling and Search Products  Ads can provide indirect information here as well.  Recall signaling-efficiency effect: even if a search good advertisement contains no direct information, the fact that the good is advertised may suggest that the seller is efficient  However, search goods offer greater potential for direct information transmission through advertising  I.e., ads for experience qualities is dominantly indirect information and advertising for search qualities is dominantly direct information

13. Evidence of the Signaling Theory  Advertising intensity is higher for experience goods  The ratio of TV to magazine advertising is significantly higher for experience goods  Search goods are especially conducive to the transfer of direct information

14. Memory Jamming View of Advertisement

15. Memory Jam  Why do familiar brands such as Coca-Cola and McDonald’s advertise so heavily?  With the average American drinking 10 gallons of Coca-Cola each year, it’s hard to believe there is much left for most consumers to learn about what’s inside the can.  Advertising might also influence the way consumers encode and recall their consumption experiences.

16. Memory Jam  Psychological studies show that people can quite easily forget the origin of a memory.  E.g. the stranger’s face is familiar, the individual cannot remember why.  When people don’t directly recall the source of a memory, they use what they know to fill in the gaps.

17. Memory Jam: Experiment  Researcher gave participants orange juice spiked with salt and vinegar.  Results showed that people who watched advertisements for the juice after the taste test remembered the juice as tasting good.  Even though what they actually consumed was designed to taste terrible.  Ads changed recollection of the sensory experience of tasting the juice, even in the very short-term.

18. Memory Jamming View: Formalized  Economic theory of advertising based on limited consumer memory  Consumers learn through experience: how much they enjoy consuming a firm’s product  Each consumer stores in memory the utility he has received from consuming the product during each past experience  At the point of purchase, the consumer recalls the utility of these experiences to memory

19. Memory Jamming View: Formalized  The firm can use advertising to change the likelihood that the consumer will remember a favorable consumption experience  Consistent with a large literature in the psychology of memory

20. Example: Breakfast Cereal Industry

21. Memory Jamming  Average preschooler sees 642 ads/year on TV  Memorable slogans  Lucky Charms: They’re magically delicious!  Paired with creative cartoons- easily recall figures and mascots

22. Example: Soft Drink Industry

23. Memmory Jamming  Need for the players to advertise heavily  Reminds the experience more than what is inside the can  Changes the way a consumer remembers an experience  Coca-Cola’s main type of advertising

24. Supply Side Advertising

25. Combative Advertising  Combative advertising, a characteristic of mature markets, is defined as advertising that shifts consumer preferences towards the advertising firm, but does not expand the category demand.  Not about influencing the consumer preferences, but rather about the supply side and advertising  Redistributes consumers among brands. If the real differences between brands are modest, then combative advertising may be excessive  Basis of Prisoner's dilemma in advertising

26. Prisoner's Dilemma

27. Advertising Wars  The prisoner's dilemma applies to advertising  All firms advertising tends to equalize the effects  Everyone would gain if no one advertised  Advertising Wars Two firms spend millions on TV ads to steal business from each other. Each firm’s ad cancels out the effects of the other, and both firms’ profits fall by the cost of the ads.

28. Cigarette Advertising on TV  All US tobacco companies advertised heavily on TV  Surgeon General issues official warning  Cigarette smoking may be hazardous  Cigarette companies fear lawsuits  Government may recover healthcare costs  Companies strike agreement  Carry the warning label and cease TV advertising in exchange for immunity from federal lawsuits. 1964 1970