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IAI Actuarial Core Principles · Business Economics · Impact of advertising on sales and demand

A bank argues that its advertising is pro-competitive. Which argument would most support the view that advertising can IMPROVE economic welfare?

The pro-welfare argument is that advertising informs consumers about prices and products, reducing search costs and helping entrants compete. This sharpens competition and can lower prices, whereas barriers to entry, lower elasticity and cost pass-through are arguments that advertising harms welfare.

  1. AIt raises barriers to entry by creating brand loyalty
  2. BIt makes demand less price elastic, allowing higher margins
  3. CIt provides consumers with information on prices and products, lowering search costs and encouraging competitionCorrect
  4. DIt increases the firm's costs, which are passed on as higher prices
  5. It differentiates near-identical products so that consumers pay a premium

Explanation

The welfare-enhancing view stresses information: advertising lowers search costs, helps new entrants and makes markets more competitive. The other options are standard arguments that advertising harms welfare through barriers, reduced elasticity or higher costs.

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