The tobacco industry maintains that cigarette advertising does not increase the incidence of smoking. If this is so, why do firms engage in advertising? Should tobacco advertising be banned?
Qn 13) The tobacco industry maintains that cigarette advertising does not increase the incidence of smoking. If this is so, why do firms engage in advertising? Should tobacco advertising be banned?
The tobacco industry asserts that cigarette advertising would unequivocally not increase the occurrence of smoking. This is used to justify their continued investment on precisely such ads, the two main purposes being for strategic reasons, in order to differentiate their products hence generating profits, ensuring the market demand curve for cigarettes is more price-inelastic. The topic as to whether tobacco advertising should be banned has been fiercely debated and this essay seeks to address the benefits and costs of such a ban in order to evaluate whether it should indeed be carried out.
Advertising can be better understood when applied to game theory, it is a static game in which a firm can choose to advertise and not advertise with two possible pay-off functions. Firms can choose either to collude, whereby they sign a legally-binding agreement in order to ensure the other firm does not renege, thus maximizing net profits for both firms. On the other hand, firms may choose the non-cooperation strategy if they do not trust each other enough and if the transaction cost of a legally-enforced agreement is prohibitively high. For either the collusion or non-collusion case, advertising is a Nash equilibrium, defined as a set of strategies such that when all other players use these strategies, no play can obtain a higher pay-off by choosing a different strategy. By referring to figure 1 and 2, if firm 1 advertises, firm 2 cannot obtain a higher pay-off if it chooses not to advertise be it either the collusion or non-collusion case. Such a Nash equilibrium is self-enforcing whereby no firms want to deviate by choosing another strategy. In both these cases, there is a dominant strategy equilibrium whereby the best move for a firm regardless of what another firm does would be to advertise.
Figure 1 (collusion pay-offs)
Figure 2 (Non-collusion pay-offs)
It is also possible that advertising is in fact a dynamic game since these firms move sequentially or simultaneously repeatedly over time. These firms have perfect and prior knowledge of other firms’ advertising activities and thus they have the ability to alter their advertising campaigns by predicting their rivals’ actions. As such firms could advertise because they desire to “stay on top” of their rivals and continually change their advertising campaigns to suit the changing times and trends. This is an example of a tit-for-tat strategy whereby rival firms attempt to undercut each other’s sales and profits by continually increasing advertising expenditure to promote their tobacco products and hence steal marker share from each other. Furthermore, firms will reap benefits from the first mover’s advantage. For example, the tobacco market is subject to buyer uncertainty, tobacco purchasers being generally unsure of prices and information regarding the goods sold, if firms can make the first move in advertising and getting out their brand name quickly, more people will try the good. Brand loyalty forged first results in greater revenue and also erects a barrier of entry against other new competitors trying to enter the tobacco industry.
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Firms engage in advertising for strategic reasons in order to boost net profits, sometimes at the expense of their rivals. Net profits refer to total profits minus the costs incurred by the firms. A firm utilizes advertising to differentiate its product from rivals. More specifically, tobacco firms may cite factors including greater emotional “kick” or document scientific findings that their specific brand of cigarettes can relieve stress for example, in their ads. Firms can increase its profits if it convinces consumers their brand of product is superior. They played around with the idea of secret ingredients or chemicals that were unique and developed in world-class laboratories, providing information to the consumers of the clear benefits of consuming their products. Colgate, a famous toothpaste company, indicated their products contained the chemical Gardol, and retaliation by other firms promptly went underway with Gleem claiming their goods had GL-70 and Crest, fluoristan. As can be seen, advertising is a sort of product promotion and branding which make firms’ goods more unique in the midst of intense competition from rival firms.
The second reason why firms carry out advertising is to fit their intentions and target specific groups like children and women. This is mainly in order to boost their market share. For example, firms might choose to hire famous athletes or performers to advertise their products in order to target groups like children and teenagers, who are readily impressionable. Firms in certain industries like tobacco may attempt to convince consumers that they cannot live without the product. All these have the propensity of making the firm’s demand curve more price inelastic as the consumers have the compulsion and greater willingness to purchase the good. As a result of the price inelastic demand curve, these firms can now charge a higher price for the good. Furthermore, the firm’s market share is increased as the price of the sales rise, resulting in a larger proportion of the market being captured by the firm in question
The prime motive of firms to advertise is maximizing profits; unfortunately, this is often at the expense of negative externalities: tobacco ads will only increase cigarette sales and consumption regardless of what the industry might believe. Second-hand smoke can result in increased incidence of disease and illnesses which can be debilitating and hence possibly affect productivity of workers. Furthermore, smoking might become a “culture” due to aggressive advertising, leading to negative externalities in the form of social ills. A negative externality is a cost to the third party not taken into account by the price mechanism or affecting producers or consumers themselves Hence due to the external marginal cost, there is a divergence in the social and private marginal cost curves. Since the producer only takes into account private marginal benefit and cost, the equilibrium quantity of tobacco produced will be Qe. Hence, there will be overconsumption of cigarettes of Qe-Qse, leading to societal deadweight loss of area ABC (refer to figure 3).
Figure 3: Deadweight loss and overconsumption arising as a result of the negative externality due to smoking cigarettes
To correct this market failure, the government may use methods like taxation and regulation; however, all these costs could strain the government budget. Furthermore, tobacco taxes will be a regressive one, hence worsening income inequality. To eliminate the market failure, the government can intervene by banning tobacco advertisements altogether, effectively reducing consumption of cigarettes to the socially efficient level. The negative side of this is that the government would forego potential tax revenue obtained from increased consumption of the cigarettes but the societal welfare benefits gained from decreased consumption of tobacco should outweigh the loss in revenue.
The tobacco industry is highly concentrated with a small number of relatively large firms. It possesses an oligopolistic market structure. Oligopolistic firms tend to compete not by engaging in price wars but instead utilize non-price competition more extensively, relying primarily on advertisements and other marketing techniques. If such advertisements are completely banned, firms within the industry would not be able to survive, losing their principal means of production promotion and branding through advertising. This would lead to increased unemployment as workers in the tobacco industry are retrenched due to an increasing number of firms being unable to compete, leading to their eventual closing down. Advertising firms and the relevant subsidiary companies will also suffer as a result of the total ban of tobacco advertisements.
Further, it seems at first glance that reducing tobacco advertising will lower sales and death rates. However, the problem is that by limiting tobacco advertising, producers are left more to spend in other ways that could raise sales. Tobacco firms may use the money they save to increase sales either by lowering prices or increasing the quality of their cigarettes. The prohibition of ads can in fact increase smoking, because inducement of lower prices could be stronger than the previous inducement from TV advertising. By using demand analysis, the downward movement along the demand curve due to lower prices could outweigh the downward shift in the demand curve as TV advertising disappears.
In spite of these potential pitfalls when the government bans tobacco advertisements completely, there are certainly numerous benefits to be reaped from the ban. One of which is the potential reduction in the consumption of cigarettes which is deemed as a demerit good due to its pernicious effects on general health and society. Advertising generates people’s wants for smoking, an aspect for the demand of cigarettes which includes consumers’ willingness to procure the good. Tobacco ads can distort facts and portray smoking or purchasing cigarettes as being fashionable and trendy, targeting groups like teenagers, encouraging some to begin smoking and even others who have already quit to start smoking again, counteracting the government’s efforts to curb smoking to begin with. Advertisements appeal to people’s psychology and its implications could be far-reaching. Even worse, such tobacco ads boost consumption of tobacco products through persuading the consumers that it is a rational choice. Hence when people purchase the goods, it is scarily due to rational behavior. A study of 22 high-income countries by Asian Journal concluded that comprehensive bans on tobacco advertising could reduce tobacco consumption by up to 7.4%. Through the ban, demand for tobacco products will fall, leading to leftward shift in demand curve and hence a fall in the quantity demanded (see figure 2).
Proponents of banning tobacco advertisements completely point to game theory as an economic explanation as to why such complete bans would benefit the individual tobacco firms due to net profits reaped. This is further supported by a paper from scholars Calfee and Ringold (1990), who argue that when advertising is not banned, “adverse information in the ads”, referring to the mandatory health messages within the ads, would hurt the whole industry and dampen overall sales. The key is that the advertising itself aids the brand who has paid for it in order to generate publicity for the brand and the related tobacco products. Such publicity would boost the firm’s net profits. However, whilst complete bans might result in decreased publicity, not spending the firms’ funds on advertising has the effect of actually reducing the costs incurred, hence increasing the firms’ net profits by other means. The strategy of the firm in the case of a ban would be to cut advertising costs altogether in order to boost net profits and hence maintain competitiveness under the circumstances of a ban. Firms can strategize, choosing to reduce the cost side of the equation completely, for instance not using advertising as well when other firms attempt to circumvent the ban by other methods like sponsorships.
Overall, I feel that banning tobacco advertisements completely is not a good idea. Besides, firms can always switch to alternative measures to promote their products via promotions and sponsorships to counteract this. I suggest a regulatory panel be created to filter out advertisements that promote such products as a form of “culture”. However, not all the ads should be banned, there should be a degree of freedom for these firms to advertise, promote their products and hopefully provide information to the public to correct asymmetric information transparently. The government should focus its efforts on education to tackle the root of the problem, inculcating the correct values into the nation’s youth from a tender age in order for them to internalize the consequences of smoking, hence reducing their perceived marginal benefits of smoking which will result in decreased consumption of smoking (refer to figure 3)