#REACH2014 – The Economics of Advertising and Digital Technology – Swati Bhatt

By ANEESH RAI

Though she was unfortunately unable to join us for REACH, Swati Bhatt, Professor of Economics
at Princeton, was kind enough to share her presentation and a short paper on the ‘Economics of Advertising and Digital Technology’. The full document is available upon request.

Advertising works in the very first place because of the flexible preferences of consumers, and it affects demand for goods and services in two ways. Either it shifts the demand curve outwards, through
increasing sales/market share, and creating new markets, or it decreases the elasticity of demand
through branding, and creating customer loyalty.

The two major kinds of advertising are persuasive advertising – which bends the demand curve by
creating genuine (or spurious) product differentiation and brand loyalty. The second kind is informative advertising, which increases demand by providing basic or complementary information about the product.

Digital technology has also radically affected the face of advertising. Through digital technology, today we are constantly, continuously, and ubiquitously connected. Connectedness implies that information can be transmitted with constant fixed costs and zero marginal costs providing supply side scale economies. In the digital world we can distinguish between paid and unpaid advertising. In the latter category we have customer reviews, either on a general website such as Yelp or on a social network. Reviews on a social network can be made available by individuals voluntarily sharing links or by firms paying users to “like” their product. Social advertising is the term that applies to both forms of customer reviews.

All of this raises the question of whether investing in advertising and branding is a feasible strategy. On the positive side, information cascades leads to viral marketing by consumers so reputation, good or bad, spreads instantaneously. Social networks lead to global phenomena so we get collective outcomes. This phenomenon is reinforced by multiple links between product and consumer. So social media and multichannel advertising, via reputation effects and persuasive advertising can create strong brands. Network effects on the demand and supply side add to this positive feedback.

On the negative side, there is a dramatic drop in developing competing startups due to cloud computing,
cheap digital power. Moreover, can commercial messages be consistently transmitted across social networks without firm intervention?

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