The Economic Value of Advertisements

Times Square: Ads everywhere you go. Plenty of them.

Times Square: Ads everywhere you go. Plenty of them. (That performance is also an ad.)

I remember a section on advertising being placed at the end of a chapter in my very first economics text book. It was placed there to provoke discussion but no one really bothered because it wasn’t examinable. That’s how we Singapore students are like anyways. Yet, advertising is such a core feature of our economy and also marks a critical dichotomy between business and economic schools of thoughts. Is advertising good or bad? Does it really add value or does it mock the importance of perfect information? The answer, as it always does, is both.

 

Perfect Information

The goal of symmetrical and complete information being available to all actors in the economy is deemed to be a crucial element to its well being. It is thought that consumers can only make good choices when they fully comprehend the product they wish to buy. Similarly, efficient production is achieved when firms are aware of all aspects of their factors of production and market conditions.

This is not just simply theory. The job market faces frictional unemployment due to the lack of information. Job seekers may apply for wrong positions or miss a good fit due to the lack of clear information and signals from prospective employers. Take it in any way you may, information is power and the purer it is, the better our economy is served.

 

Advertisements are no longer fact sheets. Instead, they often spew a whole bunch of subjective lies to entice the consumer dollar.

 

Under this backdrop, advertisements are a complete nightmare. Advertising has evolved over decades to move from simply bringing awareness of product features, to building a brand image and loyalty. Advertisements are no longer fact sheets. Instead, they often spew a whole bunch of subjective lies to entice the consumer dollar. A product is no longer just a product, it is a lifestyle, a choice of social identity and in extreme cases, a sign of loyalty or adoration of the firm producing it.

This move is not surprising. Advertisements are funded by firms and therefore, serve the firm’s objective of profit maximization over both the short and long run. There is no incentive for a firm to tell consumers the plain truth of their products. Worse, some firms have gone to lengths to manipulate the lack of knowledge on the consumer’s end to their advantage. But can you blame them? No. They have no obligation beyond that which is legal to look after the welfare of the consumer.

Adverts from ISPs (13/11/12): Who is telling the truth?

Adverts from ISPs (13/11/12): Who is telling the truth?

 

 

Welfare

Ah, the term that separates businessmen from economists – welfare. Welfare is not financial aid or social assistance for those in need. In our case, welfare is the additional benefit that any actor in the economy draws from making a certain decision with his wealth. For example, consumers who are actually willing to pay a higher sum for a product but end up paying less thanks to market competition, gainwelfare from this benefit.

Economists look at societal welfare as a whole. Basically, they sum up additional benefits from each and every person – may it be the consumer or the firm, etc. The goal of economics to answer the whats and hows in the operation of the economy. These questions are tuned to maximizing the welfare benefits to the entire economy. If an allocation of certain products and services is efficient and it brings the highest possible net benefit as a whole – then we’ve done our job and we mark this decision as Pareto optimal.

But business is a different ball game all together. In business, you don’t really care about anything that doesn’t affect your firm. Your goal is to maximize the benefits of your firm. There’s little consideration on the welfare of the consumer or the economy on the whole. Yes, there are elements such as corporate social responsibility. But let’s face it – Profits > CSR. Always. The fact that laws and guidelines are required to keep firms in line shows that the seemingly altruistic vision of economics is not shared by profit maximizing businesses.

 

The fact that laws and guidelines are required to keep firms in line shows that the seemingly altruistic vision of economics is not shared by profit maximizing businesses.

 

I am not here to dis business students or the entire notion of self servicing businesses. It is widely believed in economics that independent, selfish firms are needed to drive the economy forward. In fact, this sustainable mechanism of profit maximization is often the preferred answer to government control and other elements of a command economy. Economists love firms and businesses, only if they are competitive and if there is plenty of them to go around.

 

Mind Share & Differentiation

This is where advertising comes in again. For firms to inadvertently look into the welfare of consumers, they must be made to fight to the death for the consumer dollar. A monopoly that holds consumers hostage must not be allowed to occur. If so exists one, then the large profits that the monopoly is making should entice new firms to challenge for part of the pie. Over time, this balances out and the power of a firm is reduced so that consumers are king again. But advertising puts such mechanisms in jeopardy.

 

The key goal of advertising is to differentiate a product or service so that it appears to be unique and thus give the firm monopoly power even though there shouldn’t be one.

 

The key goal of advertising is to differentiate a product or service so that it appears to be unique and thus give the firm monopoly power even though there shouldn’t be one. Take for example, the bitter fight between Apple and Samsung. Both companies are essentially making the same product – a smartphone that is able to do many things besides calling and texting. If you would to break down the iPhone 5 and the Galaxy S3 to their bare functions – then there is little difference between the two. They are products that are nearly identical in functionality (and arguably form) yet advertised to be so different.

Advertising allows Apple and Samsung to hold monopoly status in hope that people believe that their products are as different as they make it out to be. This protects their profit margins from being eroded by their closest competitors. For now, it is working beautifully for both Apple and Samsung. Consumers will only benefit when both giants start gouging each other. Unfortunately, advertisements are slowing that down.

Samsung brands Apple consumers in its commercial.

Samsung brands Apple consumers in its commercial.

Advertising is not just about being different from competitors its also about brand loyalty and maximizing mind share. It can be argued that the images associated with a product in an advertisement, skews consumer perception of the product. For example, Microsoft is heavily using celebrities to push its latest iteration of Windows Phone. It hopes that such association will draw the same crowds that follow these celebrities. This is not new. Apple uses Hollywood names to do the same. The idea is simple – get the backing and loyalty of a certain consumer group that will no doubt reap sustained funds in multiple product sales. To this, Samsung employs aggressive advertising in direct competition for mind share. It has mocked Apple fans as sheep in advertisements worldwide.

It is clear that the battle for consumer dollars goes beyond simply making better products. Whether consumers benefit from such peripheral competition is highly questionable.

 

Value Add

The counter argument that defends advertisements is that advertisements add value to the product. Traditional minds believe that the value of a product comes entirely from what it serves and how it looks. Yet, new arguments are made that there is so much more to just innate value. Advertisements reaffirms consumer choice and adds perceived social value that can be just as important as the product itself. It may make a product seem better than it really is, but if a consumer gains satisfaction out of it, isn’t that money well spent?

Is irrational consumer behavior fine as long they enjoy it?

Is irrational consumer behavior fine as long they enjoy it?

 

Subjective Satisfaction

The value of advertisements boils down to the utility or satisfaction of a consumer. No one exactly knows what makes consumers happy. Is it value? Image? Class? Identity? Or all of the above? It is foolish to believe that consumers are alike. Priorities and preferences possibly vary widely from consumer to consumer.

As such, no one can pinpoint the actual economic value of advertisements. Subjectivity abounds and it is nearly impossible to quantitatively measure its worth.

This is probably why advertising (marketing) is an entire discipline of its own in business, yet relegated to the appendix of an economics textbook.



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