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

Which statement about advertising and market power is most consistent with the argument that advertising reduces welfare?

Critics say advertising builds brand loyalty, which makes demand less price elastic and raises entry barriers because newcomers need heavy spending to compete. This sustains market power and higher prices, reducing consumer welfare, in contrast with arguments about information or economies of scale.

  1. AAdvertising always lowers average cost through economies of scale, so prices fall
  2. BAdvertising builds brand loyalty that makes demand more inelastic and raises barriers to entry for new firmsCorrect
  3. CAdvertising increases the number of firms and lowers concentration
  4. DAdvertising only transmits factual information about price
  5. Advertising shifts the supply curve outwards, lowering prices

Explanation

Critics argue that persuasive advertising creates brand loyalty, making demand less elastic, allowing higher prices and deterring entrants because rivals must match large advertising outlays. The other statements support the pro-advertising view or are incorrect.

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