Persuasive and Informative Advertising: A Classroom Experiment

Abstract

The authors outline a pair of classroom activities designed to provide an intuitive foundation to the theoretical introduction of advertising in monopoly markets. The roles of both informative and persuasive advertising are covered. Each student acts as a monopolist and chooses the number of (costly) advertisements and the price. The experiments are intended for intermediate microeconomics or industrial organization courses, but might be used in any course that covers advertising models.

Keywords:

• advertising
• classroom experiment
• monopolist
• undergraduate industrial organization

JEL codes:

• A22
• C90
• D21
• L10

Notes

1. Several articles illustrated how students benefit from classroom experiments relative to students who do not participate in experiments, including articles by Frank (1997), Gremmen and Potters (1997), Emerson and Taylor (2004), Dickie (2006), and Durham, McKinnon, and Schulman (2007).

2. Pepall, Richards, and Norman (2002) presented a model of advertising as providing crowd appeal, a scenario similar to the view of persuasive advertising where the demand curve rotates along the price axis with advertising.

3. For example, Shy (1996) discussed the model of Dixit and Norman (1978), which presented a simple method for evaluating the impact of persuasive advertising. Shy proposed that this model implies the socially optimal level of persuasive advertising is above the equilibrium level in a monopoly market, but cautioned students that this holds only for a very specific model.

4. If decision making under uncertainty is covered at some point prior to the advertising activity, the instructor may wish to remind students of the assumption that firms are risk-neutral. However, if advertising is presented before decision making under uncertainty, the instructor can use the outcome of the advertising activity to address how the assumption of firm risk-neutrality affects predicted behavior. For a discussion of risk preferences, the instructor may note that a student's attitudes towards risk can affect the outcome of the classroom activity.

5. Copies of the instructions are available on request from the authors or may be downloaded from http://bafree.people.wm.edu/advertising_instructions.pdf.

6. Questions that can be assigned for homework or used to stimulate classroom discussion, as well as the graphs that were used in our own classroom discussion following implementation of the experiment, are available from the authors on request or may be downloaded from http://bafree.people.wm.edu/advertising_discussion.pdf.

7. Alternatively, the persuasive treatment (activity A) can be given as a homework assignment before doing the informative treatment (activity B) in class. Assigning activity A as homework might be useful in shorter classes, allowing for more class time to be devoted to activity B and in-class discussion. An additional benefit of assigning activity A as homework is that it provides students with ample time to search for the optimal price-advertising combination. Alternatively, before activity A, the instructor can assign homework that gives the students the demand schedule for zero ads and the demand schedule for 10 ads. Students could determine the optimal price and quantity for each demand schedule and be asked how much the firm would be willing to pay to face the higher demand schedule. This type of preclass exercise will help ensure that students understand the problem they face in activity A.

8. For convenience and speed of implementation, we recommend the instructor number several sets of poker chips prior to the class, so that several student assistants may use the numbered poker chips to run the activity. In a class of 20 students, we used four sets of numbered poker chips to implement the informative-advertising activity.

9. Incentive structures for in-class activities vary from instructor to instructor and can include monetary incentives, candy, class participation points, or extra credit points. For the results presented in this article, we used the common strategy of providing a monetary incentive; students were informed that a randomly selected student would be paid a percentage of their total earnings (1 percent) at the end of the class period. Under this payment structure, however, the marginal expected monetary prize of a change in ads is quite small.

10. In order for profits to be concave in advertising expenditures, the second derivative of A(a)2/4b—C(a), in which a is the number of advertisements, A(a) is the vertical intercept of the inverse demand, and C(a) is total advertising costs, must be negative. Concavity of profits net of advertising therefore requires advertising costs C(a) to be sufficiently convex.

11. Note that the consumers in activity B begin with higher initial willingness to pay than consumers in activity A. This allows for the postadvertising demand curve given maximum advertising to be identical across treatments.

12. Thus, one feature of this classroom experiment is that it provides a structural interpretation behind the textbook treatment of having the demand curve rotate out.

13. Alternatively, the experiment could be performed in an hour-long class with discussion during a separate class period, or each treatment (activity A, activity B) could be performed and discussed in separate class periods.

14. Instructors may wish to direct their students to the optimal result by asking a question such as “If your price is $9, what will happen to profits if you increase your advertisements by 1?”