The Economics of Organisations and Strategy

Chapter 13 Product Differentiation and Advertising

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The Economics of Organisations and Strategy Chapter 13 - Question 1 Chamberlain’s model of monopolistic competition assumes negligible cross price elasticities of demand which are implied by the assumption of zero conjectural variations. The purpose of this assumption is to: End B C A D Ensures consumers are well informed about alternatives; Limit the substitutability between products; Enable firms to determine profit maximising output; Create scope for horizontal demand curves.

The Economics of Organisations and Strategy Chapter 13 - Question 2 One approach to dealing with the problem of limited substitutability is the concept of a product space. The model’s two axes show: End B C A D Horizontal and vertical differentiation; Horizontal and vertical distance to market; Horizontal and vertical boundaries for rivals; Horizontal and vertical integration.

The Economics of Organisations and Strategy Chapter 13 - Question 3 In Lancaster’s attributes model starting at point E, if the price of receiving the attributes A 1 and A 2 rises, where will the consumer move to: End B C A D ;; or ; A1A1A1A1 A2A2A2A2 X Y Z B E C D A V0V0V0V0 V1V1V1V1 0

The Economics of Organisations and Strategy Chapter 13 - Question 4 Consumption of a Veblen good is based in part on the notion of conspicuous consumption. In this respect it is an extreme form of: End B C A D A bandwagon effect; Horizontal differentiation; Spatial differentiation; Vertical differentiation.

The Economics of Organisations and Strategy Chapter 13 - Question 5 The equation provides the formula for: End B C A D Optimal advertising intensity; Brand advertising; Maximum advertising intensity; Profitable advertising. A p  c pQpQ p .  QA

The Economics of Organisations and Strategy Chapter 13 - Question 6 As a source of information, advertising serves which of the following purposes: End B C A D All of the following; Information on individual sellers; Information on a product’s attributes; It helps potential customers evaluate offerings.

The Economics of Organisations and Strategy Chapter 13 - Question 7 Which of the following could not be used as a justification for using advertising to change consumers’ preferences: End B C A D Consumers’ tastes are constantly changing; Individuals are the best judges of their own welfare; Consumers benefit from perfect information; Advertising by a firm implies faith in it’s quality claims.

The Economics of Organisations and Strategy Chapter 13 - Question 8 Advertising intensity has been linked to market structure. Which of the following most accurately describes the relationship between concentration and advertising intensity: End B C A D As concentration declines advertising intensity at first falls and then rises; As concentration increases, advertising intensity follows an inverted U-shape; As concentration declines, advertising intensity rises; As concentration rises, advertising intensity follows a U-shape.

The Economics of Organisations and Strategy Chapter 13 – Answer 1 Correct answer: When considering differentiated products, the issue that needs to be addressed is just how many product varieties should an industry produce. Without some mechanism for limiting the substitutability between products the cross price elasticity will be very high, implying effectively that each firm faces a horizontal demand curve for its product. Limited substitution is necessary to deliver a downward sloping demand curve. EndReturn

The Economics of Organisations and Strategy Chapter 13 - Answer 2 EndReturn Correct answer: The vertical axis shows vertical differentiation, the horizontal axis horizontal differentiation. Moving up the vertical axis reflects an increasing quantity of quality attributes and therefore higher production costs. Moving along the horizontal axis implies the same quantity of quality attributes, but products are differentiated by design, packaging and taste.

The Economics of Organisations and Strategy Chapter 13 - Answer 3 Correct answer: The rays 0X, 0Y and 0Z show the quantities of the attributes A 1 and A 2 delivered by the three X, Y and Z. If the price of Y rises the consumer will be forced to move down the ray towards the origin. However, given the preference map instead of moving to A the consumer will seek the combination of A 1 and A 2 that delivers the highest level of satisfaction; namely point C which must lie on a higher indifference curve than point B. EndReturn

The Economics of Organisations and Strategy Chapter 13 - Answer 4 EndReturn Correct answer: the notion of conspicuous consumption arises from the idea that a consumer’s utility is enhanced by the belief that in the eyes of others, consumption confers considerable affluence and it is this attribute that is highly valued by consumers. The more vertically differentiated a product the greater its value.

The Economics of Organisations and Strategy Chapter 13 - Answer 5 Correct answer: The equation shows the Dorfman-Steiner condition for optimal advertising intensity – that is the ratio of advertising expenditure (A) to the value of sales (pQ). This is determined by the product’s price- cost margin multiplied by the elasticity of demand with respect to advertising. EndReturn

The Economics of Organisations and Strategy Chapter 13 - Answer 6 Correct answer: In a world of asymmetric information and bounded rationality, advertising can serve the purpose of providing information. Specifically it can inform potential buyers of the existence of individual sellers, it can provide details on the nature and characteristics of a product’s attributes and it can help potential customers evaluate quantity and price. EndReturn

The Economics of Organisations and Strategy Chapter 13 - Answer 7 Correct answer: Advertising has no purpose in a world of perfect information. Advertising devoted to building a band image is essentially attempting to help potential customers identify quality before they purchase. Only a firm that produces a quality product can afford the cost of advertising, otherwise having sample the product consumers will not repeat purchase if it disappoints. EndReturn

The Economics of Organisations and Strategy Chapter 13 - Answer 8 Correct answer: Empirical studies show that monopolists tend to have a lower level of advertising intensity than oligopolists. For oligopolists optimal advertising depends on a firm’s conjectures regarding expenditure by rivals which cause the level of advertising intensity to rise excessively. As market structure moves towards monopolistic competition and on towards perfect competition, so the optimal level of advertising intensity declines. EndReturn

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