Case Study: The role of advertising

Firms often spend thousands to millions of dollars per year on advertising and other forms of marketing. In terms of demand analysis, the aim is twofold. Advertising is designed to inform the consumer of the product and influence their tastes and preferences. A successful advertising campaign should result in an increase in the demand for the product at each given price level, thereby shifting the demand curve to the right.

Advertising is also designed to increase brand loyalty. Successful advertising and marketing will enable consumers to associate a certain lifestyle or image with the product. If firms are able to successfully created a sense of brand loyalty, then this makes their competitors' products less viable as alternatives. Therefore, a successful advertising campaign can decrease the PED for their product.

A lower PED for a product may allow the company to charge higher prices and gain an increase in revenue. This may help to explain why some designer or luxury brands are able to charge far more than what it costs to produce their product.

Based on this, answer the following questions:

a.Outline two reasons why businesses spend millions of dollars on advertising.

b.Explain what is meant by brand loyalty and outline how advertising can generate brand loyalty.

c.Discuss the possible relationship between an increase in advertising expenditure, brand loyalty and the PED.

d.Explain why it is considered to be profit-maximizing behavior if a business raises the price on those products with a low PED.