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?

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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 ...

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