Advertising is an essential part of doing business, and it serves many functions beyond informing consumers that products and services exist. Advertising has a number of known economic con-sequences which have been studied: it may affect total demand in the economy, aggregate demand for products within an industry, the ratio between consumer spending and saving, and the market shares of firms competing within the same industry. While many of the theories and principles of advertising are not absolute, advertis-ing has been shown to have major influences on market conditions and to play an important role in shaping market strategies.
There is no fixed formula for advertising success. For this reason, the results of economic studies are often qualified by statements indicating that an effect may hold true only if certain conditions are present. What works for one firm might not work for another firm facing stronger competition. A comparative advantage or an economy of scale may exist only for a period of time before the relative advantage begins to fade. Nonetheless, it can be shown that various relationships between advertising and economic advantages can, and often do, occur.
This paper will examine the role of advertising in establish-ing and supporting product differentiation, and will explore the relationship between successful product differentiation and market power. It will support the argument that product differentiation through advertising can create market conditions which may serve as a barrier to entry for competitors. Economic forces which create these conditions will be examined, and examples of market power gained through product differentiation will be given.
Advertising and Product Differentiation
Product differentiation exists when there is something in a buyer's mind to separate one product from another. If products were homogeneous, they could be easily substituted for each other. When a product...