Advertising costs are effectively paid for by consumers
You keep asserting this. You provide no evidence or argument that it’s true. I agree that advertising costs are likely to be paid for by consumers in (say) the petrol market, although given that market is complicated by franchises, even there it may not be true. I think they are very unlikely to be paid for by consumers in markets featuring (partial) monopolies, such as Coke/Pepsi. So no, I don’t think that if Coke quadrupled its advertising budget it would be able to pass on the cost to consumers.
You seem to think the soft drink market is “highly competitive.” And you’re right, in the sense that everyone is trying to bring the best products to market, to make a profit. But you’re wrong, in the sense that the products are not direct substitutes in terms of consumer experience. Coke does not taste the same as Pepsi, and only the Coca-Cola Corporation knows how to make Coke. This is why Coke can sell their product for twice the price of some supermarket own-brand cola; they are earning rents on their intellectual property. The same goes, to a lesser extent, for Pepsi. This is a partially-monopolistic market, very different from the market for electronics, where the products are functional substitutes, and so are close to commodities, and indeed, cost savings are passed on.
And note that we see the most advertising precisely in partially monopolistic markets, and very little in commodity markets, precisely because of the effect on prices.
You keep asserting this. You provide no evidence or argument that it’s true.
I am sorry, but what other options are there? The advertising costs are paid out of interest on the firm’s bank balances? Out of tax subsidies? Out of charity donations?
The firm’s costs are paid out of the firm’s revenues. If the firm’s revenues come from selling things to consumers, the consumers are paying for the firm’s costs—all of them, including production, distribution, advertising, office space, janitors, and executives’ membership in the golf club. The consumers get the product in exchange, of course.
But you’re wrong, in the sense that the products are not direct substitutes in terms of consumer experience.
As you mentioned, “You keep asserting this. You provide no evidence or argument that it’s true.” Let me provide a counterexample.
Many fast-food chains have exclusive contracts with Coke or Pepsi. McDonalds, for example, serves only Coke. Given this, you can directly observe whether Coke is accepted as a substitute for Pepsi: often enough at the counter you can hear the following exchange:
-- What’s your drink? -- Pepsi (automatic answer as that’s what the person is used to drinking) -- Sorry, we have only Coke.
And at this point the customer can either accept the substitution (and say “Coke is fine”) or decline it (and say “I’ll have X instead”). I don’t have actual data, but I’ve seen this case happen many times and the number of people who will accept Coke is much higher than the number of people who will refuse it.
very different from the market for electronics, where the products are functional substitutes
Coke and Pepsi are functional substitutes. They don’t taste exactly the same, but then Samsung’s and HTC’s phones don’t look and behave exactly the same either.
note that we see the most advertising precisely in partially monopolistic markets, and very little in commodity markets, precisely because of the effect on prices.
Citation needed. Advertising is basically buying market share. I would argue that we see most advertising in highly competitive markets where you can buy market share. That means that you can differentiate your product and convince part of the public that the product is better than the other guy’s and not just because it’s cheaper. And I’m not willing to call all markets with differentiable products “partially monopolistic”.
Your ability to persuade an average bloke that petrol of brand X is better than petrol of brand Y is limited. Therefore your ability to buy market share is limited. Therefore you don’t spend much money on advertising. But you ability to persuade the same bloke that beer X is better than beer Y is much higher. Thus you can buy market share and advertising beer is worth it (for the firm, of course).
I am sorry, but what other options are there? The advertising costs are paid out of interest on the firm’s bank balances? Out of tax subsidies? Out of charity donations?
Out of the firm’s profits.
The firm’s costs are paid out of the firm’s revenues. If the firm’s revenues come from selling things to consumers, the consumers are paying for the firm’s costs—all of them
Yes, this is true, in a sense. But it says nothing about what changes when one of these costs change. If the cost of office space increases, does that raise prices for consumers, or does it mean the firm has less to spend on golf club membership, or a mixture, or what?
Consider the toy example I gave above when I’m selling Coke to Alan and Bob—if you recall, I set the price at £2 per litre, and am making £1.90 in profit. Now suppose I start spending £1 in advertising. Do I raise the price to £3? Nope; I already set my price at the level that would maximise my revenues. It just means my profits are now only 90p.
Regarding substitutability: yes, Coke and Pepsi are partial substitutes, and electronic goods are not completely commodities. But Colas are much less substitutable than Samsung and HTC, or Dell and HP. The question is one of degree.
So try a model where all cola costs 10p a litre to produce, Alan values Coke and Pepsi equally at £3 a litre, Bob and Chris value Coke at £3 a litre, Pepsi at £1 a litre, and Dave and Edward value Coke at £1 a litre, Pepsi at £3 a litre. In equilibrium, how much will Coke sell for? How much will Pepsi sell for? Now suppose Coke and Pepsi each spend £1 on advertising. How much will Coke sell for? How much will Pepsi sell for?
Advertising is basically buying market share. I would argue that we see most advertising in highly competitive markets where you can buy market share. That means that you can differentiate your product and convince part of the public that the product is better than the other guy’s and not just because it’s cheaper. And I’m not willing to call all markets with differentiable products “partially monopolistic”.
Yes, we see advertising in “competitive” markets in the sense you are using (which appears to be something akin to “contested”), but not in the economic sense of “perfect competition” i.e. commodities. You are not disagreeing with me there. You may not be willing to call markets with differentiable products “partially monopolistic”, but I’m afraid I’m using standard usage. See e.g. Wikipedia:
Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes.
You should also note that as advertising is a fixed cost, not a marginal cost, so it wouldn’t affect the marginal cost anyway...
Unfortunately I feel like I’ve reached the end of the line trying to explain this to you.
Bollocks. Profits = revenues—costs. You can’t pay costs out of profits.
I already set my price at the level that would maximise my revenues.
The whole point of advertising is to change that level. You’re spending a pound per litre in order to change the equation which determines the proper price.
If you expect your advertising to reduce your profits why would you advertise in the first place?
Hi you two (Lumifer and Salemicus). A are you aware that you are having a wordy public conversation on a somewhat political topic more than two times deeper than the LW comment thread depth? I had trouble even finding the start of your conversion due to the limits. No one will vote on you and you clutter the recent comments. I recommend to both of you to discuss this as a privat conversation.
Thank you for taking the time to giving feedback this deep in the thread (hurray LW notification system). I reconsider my recommendation now. And will look away next time.
I am aware that we are having a wordy public conversation. I don’t consider microeconomics to be political, even “somewhat”. I don’t care whether anyone will vote on these posts or not. As to “cluttering” recent comments, all posts do that. If you don’t want to read this subthread, avert your eyes.
Hi you two (Lumifer and Salemicus). A are you aware that you are having a wordy public conversation on a somewhat political topic more than two times deeper than the LW comment thread depth? I had trouble even finding the start of your conversion due to the limits. No one will vote on you and you clutter the recent comments. I recommend to both of you to discuss this as a privat conversation.
You keep asserting this. You provide no evidence or argument that it’s true. I agree that advertising costs are likely to be paid for by consumers in (say) the petrol market, although given that market is complicated by franchises, even there it may not be true. I think they are very unlikely to be paid for by consumers in markets featuring (partial) monopolies, such as Coke/Pepsi. So no, I don’t think that if Coke quadrupled its advertising budget it would be able to pass on the cost to consumers.
You seem to think the soft drink market is “highly competitive.” And you’re right, in the sense that everyone is trying to bring the best products to market, to make a profit. But you’re wrong, in the sense that the products are not direct substitutes in terms of consumer experience. Coke does not taste the same as Pepsi, and only the Coca-Cola Corporation knows how to make Coke. This is why Coke can sell their product for twice the price of some supermarket own-brand cola; they are earning rents on their intellectual property. The same goes, to a lesser extent, for Pepsi. This is a partially-monopolistic market, very different from the market for electronics, where the products are functional substitutes, and so are close to commodities, and indeed, cost savings are passed on.
And note that we see the most advertising precisely in partially monopolistic markets, and very little in commodity markets, precisely because of the effect on prices.
I am sorry, but what other options are there? The advertising costs are paid out of interest on the firm’s bank balances? Out of tax subsidies? Out of charity donations?
The firm’s costs are paid out of the firm’s revenues. If the firm’s revenues come from selling things to consumers, the consumers are paying for the firm’s costs—all of them, including production, distribution, advertising, office space, janitors, and executives’ membership in the golf club. The consumers get the product in exchange, of course.
As you mentioned, “You keep asserting this. You provide no evidence or argument that it’s true.” Let me provide a counterexample.
Many fast-food chains have exclusive contracts with Coke or Pepsi. McDonalds, for example, serves only Coke. Given this, you can directly observe whether Coke is accepted as a substitute for Pepsi: often enough at the counter you can hear the following exchange:
-- What’s your drink?
-- Pepsi (automatic answer as that’s what the person is used to drinking)
-- Sorry, we have only Coke.
And at this point the customer can either accept the substitution (and say “Coke is fine”) or decline it (and say “I’ll have X instead”). I don’t have actual data, but I’ve seen this case happen many times and the number of people who will accept Coke is much higher than the number of people who will refuse it.
Coke and Pepsi are functional substitutes. They don’t taste exactly the same, but then Samsung’s and HTC’s phones don’t look and behave exactly the same either.
Citation needed. Advertising is basically buying market share. I would argue that we see most advertising in highly competitive markets where you can buy market share. That means that you can differentiate your product and convince part of the public that the product is better than the other guy’s and not just because it’s cheaper. And I’m not willing to call all markets with differentiable products “partially monopolistic”.
Your ability to persuade an average bloke that petrol of brand X is better than petrol of brand Y is limited. Therefore your ability to buy market share is limited. Therefore you don’t spend much money on advertising. But you ability to persuade the same bloke that beer X is better than beer Y is much higher. Thus you can buy market share and advertising beer is worth it (for the firm, of course).
Out of the firm’s profits.
Yes, this is true, in a sense. But it says nothing about what changes when one of these costs change. If the cost of office space increases, does that raise prices for consumers, or does it mean the firm has less to spend on golf club membership, or a mixture, or what?
Consider the toy example I gave above when I’m selling Coke to Alan and Bob—if you recall, I set the price at £2 per litre, and am making £1.90 in profit. Now suppose I start spending £1 in advertising. Do I raise the price to £3? Nope; I already set my price at the level that would maximise my revenues. It just means my profits are now only 90p.
Regarding substitutability: yes, Coke and Pepsi are partial substitutes, and electronic goods are not completely commodities. But Colas are much less substitutable than Samsung and HTC, or Dell and HP. The question is one of degree.
So try a model where all cola costs 10p a litre to produce, Alan values Coke and Pepsi equally at £3 a litre, Bob and Chris value Coke at £3 a litre, Pepsi at £1 a litre, and Dave and Edward value Coke at £1 a litre, Pepsi at £3 a litre. In equilibrium, how much will Coke sell for? How much will Pepsi sell for? Now suppose Coke and Pepsi each spend £1 on advertising. How much will Coke sell for? How much will Pepsi sell for?
Yes, we see advertising in “competitive” markets in the sense you are using (which appears to be something akin to “contested”), but not in the economic sense of “perfect competition” i.e. commodities. You are not disagreeing with me there. You may not be willing to call markets with differentiable products “partially monopolistic”, but I’m afraid I’m using standard usage. See e.g. Wikipedia:
You should also note that as advertising is a fixed cost, not a marginal cost, so it wouldn’t affect the marginal cost anyway...
Unfortunately I feel like I’ve reached the end of the line trying to explain this to you.
Bollocks. Profits = revenues—costs. You can’t pay costs out of profits.
The whole point of advertising is to change that level. You’re spending a pound per litre in order to change the equation which determines the proper price.
If you expect your advertising to reduce your profits why would you advertise in the first place?
Hi you two (Lumifer and Salemicus). A are you aware that you are having a wordy public conversation on a somewhat political topic more than two times deeper than the LW comment thread depth? I had trouble even finding the start of your conversion due to the limits. No one will vote on you and you clutter the recent comments. I recommend to both of you to discuss this as a privat conversation.
As it happens I was finding the conversation interesting.
Thank you for taking the time to giving feedback this deep in the thread (hurray LW notification system). I reconsider my recommendation now. And will look away next time.
I am aware that we are having a wordy public conversation. I don’t consider microeconomics to be political, even “somewhat”. I don’t care whether anyone will vote on these posts or not. As to “cluttering” recent comments, all posts do that. If you don’t want to read this subthread, avert your eyes.
I will avert my eyes. I accept your decision. It was a recommendation and you don’t need to take it.
Hi you two (Lumifer and Salemicus). A are you aware that you are having a wordy public conversation on a somewhat political topic more than two times deeper than the LW comment thread depth? I had trouble even finding the start of your conversion due to the limits. No one will vote on you and you clutter the recent comments. I recommend to both of you to discuss this as a privat conversation.