Advertising and Its Effect on the Demand Curve

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THE UNIVERSITY OF QUEENSLAND
ECON7002
Markets in Action
Advertising and its effect on the demand curve

Markets in Action
Advertising and its effect on the demand curve

Advertisement has always been an important market strategy for firms to accomplish their goals. From cereal companies to airline companies, it is inevitable to go through the process of advertising. However, what purpose does advertising serve for consumers and suppliers in the market? In this report, it is to examine the relationship between advertising and the market demand curve. Moreover, the impact that advertising brings toward the consumers and the company supplying the product or service.

It is no doubt that peoples’ income is always limited relatively to peoples’ wants. Consumers therefore have to make choices among different products and services (P&S) to satisfy their unlimited wants with limited income. Firms take advantage of this issue by advertising the P&S they produce to increase their profits. There are two primary motives for companies to advertise their products and services. The first motive is to shift the demand curve to the right, meaning an increase in market demand for a product/service. The second motive is to lower the elasticity of the demand curve, meaning the demand for a product/service is less affected when the price of that product/service changes (Sloman, Norris & Garratt 2010).

There are a number of reasons that causes a demand curve to shift to the right. In the case of advertisement, changing the preferences and tastes of the consumers can have a significant effect on demand. By enhancing the taste and preference of consumers, it draws new and inexperienced customers to purchase the product/service (Acharyya & Mukherjee 2003). Therefore, advertising brings a firm’s product/service to more people’s attention and increases the people’s desire for purchasing it. Advertisements can also eliminate the possible limitations in the knowledge of consumers and familiarize them with new information about the product/service. Consumers can not review the qualities and values for most products and services in the market until it is purchased, such as kitchen appliances or automobiles. With providing information about the product/service by advertisements, the firm aims to influence the purchasing decision and raise the willingness to pay of the consumers (Erdem, Keane & Sun 2007). For example, SONY can change the consumer’s purchasing preference and taste by conducting a computer technology exhibition that displays the relevant technology information about the computers. Another example is McDonalds creating a television commercial about shaker fries to inform customers about this new product. Below is a figure illustration that shows the effect of advertising by a rightward shift in the demand curve. With the supply curve unaffected, it can be seen that the quantity demanded increases from Q to Q’ when the demand curve shifts to the right. As for the price of the product/service, it increases from P to P’.

Figure1. Effect of advertising by a rightward shift in the demand curve

Price elasticity is the responsiveness of consumer demand when the price of the product/service rises or falls. Firms therefore use advertisements to affect consumers purchasing decisions by compelling people to buy their product/service over competitors. This means to make their product/service highly inelastic relatively compared to their competitor’s substitutes. So what factors influence the price elasticity of demand? In this report, five determinants are examined. The first factor is the number and closeness of substitute product/service. For companies that have monopoly power such as oil and electricity, an advertising scheme is usually unnecessary as consumer demand are already consistent regardless of a change in price. On the other hand, firms that have competitors attempts to use advertising plans to...
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