Advertising and Demand Discovery

Advertising and Demand Discovery

In light of the attempts by Chamberlin and Robinson to replace or supplement the notion of perfect competition (see Chapter 17), the Austrian approach takes on ad­ditional interest. Among contemporary Austrian economists, Israel Kirzner, for one, views the Chamberlin-Robinson reformulation as misguided:

The new theories failed to perceive that the characteristic features of the real world are simply the manifestations of entrepreneurial competition, a process in which would-be buyers and sell­ers gropingly seek to discover each other's supply and demand curves. The new theories merely fashioned new equilibrium configurations—based, as was the theory of perfect competition— on given and known demand and supply curves—differing from the earlier theory only in the shapes assigned to these curves. In the course of attempting to account for such market phe­nomena as quality differentiation, advertising, markets in which few producers were to be found, the new theories were led to conclusions which grossly misinterpret the significance of these phenomena (Competition and Entrepreneurs/tip, p. 29).

The basis for Kirzner's claim is that the theory of monopolistic competition rules out the discovery process. There is no awareness of the need for manufacturers and consumers to experiment in order to find those products and variations that are most wanted. Like the theory it was supposed to supplement, it assumed the market de­mand to be given beforehand. A second weakness noted by other writers besides Aus-trians is that the theory offers no explanation of how product differentiation can per­sist in equilibrium, that is, why rival firms cannot duplicate those product variations that prove successful.

In particular, Austrian economics has provided fresh insights into advertising, which proved to be something of an embarrassment to traditional economic theory. If consumers always have perfect information about the products available, there is no rational explanation for the persistence of advertising. Indeed, it would seem wasteful. To Chamberlin and others, advertising was one way of conveying infor­mation to consumers about a product they knew existed. But mere persuasion was another matter. Most economists objected to persuasive advertising as unabashed hucksterism. Austrian thinking departs substantially from the conventional view. Consumers do not always know what products are available, and even if they do, they are not usually informed about their properties. Consequently, the seller has a role in capturing the consumer's attention. It matters not whether advertising is purely informational, purely persuasive, or some combination of the two. What mat­ters is that the products are noticed, for then and only then can consumers act entre-preneurially—that is, exercise their decision-making ability.

In a similar fashion, the Austrian notion of monopoly stands apart from the or­thodox view. Standard theory traditionally assumes that a monopolist's demand curve is known and that his or her ability to raise price and increase profits depends on the shape of that curve. It is not always explained how monopolists came to know the demand curve, why they are single producers, and why the threat of competition from other firms does not prevent them from acting as they do. These questions are confronted in the Austrian approach, in which the presence of monopoly in no way obviates the need for market discovery. Whether or not a firm is a monopolist, it must discover what its customers want and what they are willing to pay for it. Therefore, monopolists are subject to the same competitive market process as other firms. Moreover, monopolists must compete with producers of new and better products even if they do not face competition from producers of the same product. Hence it is mis­leading to characterize monopoly as "the absence of competition." Rather, monop­oly implies barriers to entry. Kirzner has noted:

The existence of rivalrous competition requires not large numbers of buyers and sellers but sim­ply freedom of entry. Competition places pressure on market participants to discover where and how better opportunities, as yet unnoticed, might be offered to the market. The competitive mar­ket process occurs because equilibrium has not yet been attained. This process is thwarted when­ever non-market barriers are imposed blocking entry to potential competitors ("The Perils of Regulation," p. 9).

One way to gain an appreciation for the operation of the market process is by re­viewing the socialist calculation debate that took place over an extended period of time between Mises and Hayek on the one hand and Oskar Lange and H. D. Dick­inson on the other. Mises and Hayek illuminated the enormous difficulties con­fronting socialist planners trying to emulate the market's result without an actual mar­ket in operation. Lange and Dickinson, joined later by Abba Lerner and others, maintained that efficient allocation is achievable under socialism so long as social­ist managers follow well-prescribed rules in decision making.