ECONOMICS PROJECT ON
Selling Cost
Or
Advertising Expenditure

Made by
Roll no Names 18 Srishty Jain

Abstract Selling (Advertising) Cost: Selling Cost (SC) is another outstanding feature of a monopolistic competitive market. This is in the form of advertisement expenditure. Selling Cost and Product Differentiation together enable the producer to maintain some control over market conditions and influence the shape of the demand curve. Both features are interdependent. Whenever a product is differentiated it is necessary to inform buyers; and advertisement is the only medium through which buyers can be told about superiority of that product. Selling Cost by itself is apparent product differentiation. When a product does not contain any genuine qualitative difference, buyers can be made to treat a product differently through advertisements. So whenever products are differentiated and advertised, the market becomes a monopolistic competition. These are the hallmarks of this form of market. The presence of selling cost increases the firm’s cost of production. In order to recover it, firms have to charge a higher price. The net effect of a monopolistic competitive market is pricing goods at a higher rate. Consumers have to bear this extra expenditure. For manufacturing companies, product costs are only costs that are necessary to produce a finished product. As discussed earlier in the tutorial, product costs (i.e. manufacturing costs) consist of direct materials, direct labor, and factory overhead.
Product costs are assigned to an inventory account on the balance sheet, initially. When finished goods are sold, the cost of goods sold is transferred to the income statement (expensed) and matched with the sales revenue. As product costs are assigned to inventory accounts initially, sometimes they are called inventoriable costs. Important to note, that product costs are not always expensed in the period they are incurred. They are rather expensed in the period when finished goods are sold: that is, the cost of goods sold expense is matched with the sales revenue.

INTODUCTION Product variation and advertising are the two important instrument of non-price competition by firms. A product variation refers to the changes in some characteristics of the product (for example changing the quality of the product or improving the design of it and providing better service for their products) so as to make their products more appealing to the consumers. Under monopolistic competition and oligopoly, the firms often compete through product variation and incurring selling costs or advertisement expenditure to increase the demand for their products and thereby increase revenue made. Advertising, salaries paid to staff employed for promotion of sales and other expenses on promotional activities constitute selling costs. Selling costs incurred by the firms in recent years have enormously increased. It has been estimated in recent years that in the USA more than $100 billion are spent on advertising annually. A single company McDonald, famous for its fast food, spent as much as $2.50 billion on advertising in 1984. For firms working under conditions of monopolistic competition and oligopoly, besides adjustments of price, output and product, the important decision to how much selling costs or advertisement expenditure has to be taken so as to achieve the aim of profit maximization. The first problem that is encountered in connection with selling costs is how they differ from production costs. The other important question which arises is why firms working under monopolistic competition and oligopoly incur selling costs and not the firms working under the conditions of perfect competition and monopoly. Further, how the firm will decide about the optimum level of selling costs or advertisement expenditure. And, lastly, what is the influence of selling costs on price and output of the product.
Objectives

Data
Selling costs distinguished from production costs The term selling costs is broader than advertisement expenditure. Whereas advertisement expenditure includes costs incurred only on getting the product advertised in newspapers and magazines, radio and television, selling costs include the salaries and wages of salesmen, allowances to retailers for the purpose of getting their product displayed by them, and so many other types of promotional activities, besides advertisements. Chamberlin who introduced the analysis of selling costs in price theory distinguished them from production costs. According to Chamberlin, cost of production includes all those expenses which are incurred to manufacture and provide a product to the consumer to meet his given demand or want, while the selling costs are those which are incurred to change, alter or create the demand for a product. Costs of production therefore include manufacturing costs, transportation costs, and cost of handling, storing and delivering a product to the consumers, since all of these activities add utilities to a good. And the addition or creation of utilities to satisfy the given wants is called production in economics. To quote Chamberlin, “cost of production includes all expenses which must be met in order to provide the commodity or service, transport it to the buyer, and put it into his hands ready to satisfy his wants. On the other hand, selling costs include all outlays made in order to secure a demand or a market for the product. The former costs create utilities in order that given demands may be satisfied; the latter create and shift the demand themselves. A simple criterion is this: of all the costs incurred in the manufacture and sale of a given product, those which alter the demand curve for it are selling costs, and those which do not are costs of production.” The selling costs, according to Chamberlin, include “advertising in its many forms, salaries of salesmen and the expenses of sales department and sales agencies (except where these agencies actually handle the goods), window displays, and displays and demonstrations of all kinds.” It should however be noted that the distinction between production costs and selling costs cannot always be sharply made and there are cases where it cannot be said whether product is been adapted to meet the demand, or the demand is being adapted to sell the product. For instance, it is difficult to say whether the extra cost on attractive packaging is production cost or selling cost. However, as far as advertisement expenditure is concerned, there is little doubt about its being is selling cost, since purpose of advertisements is to increase or create the demand for the product. Thus Chamberlin’s distinction is quite applicable so far as advertisements is concerned. Advertising expenditures the most important and dominant form of selling costs.
What Is The Role Of Selling Costs In Monopolistic Competition? The products have relatively higher average cost of production and sell the products at a high price due to the differentiation. The firms maximize their profits in the short term due to these high selling prices.

In monopolistic competition, the average production cost is high and the firm is not able to produce at the lowest possible cost. The firms that sell the product maximize their profits in the short run because they are selling a differentiated product and they sell them at higher prices. However, this profit would not be greater in the log run because the demand will decrease due to more differentiation by other firms and the average cost of production would be higher and the profits lower, hence causing a break even for the firm. Following are some of the easily identifiable costs of selling that contribute to selling costs: * Exhibition Expenses – Booth fees for craft shows, cost of materials for the booth, signs, and display items. * Travel Expenses - If attending out-of-town shows one should include the food and accommodations. * Advertising and Promotion - Included in the selling costs are any expenses involved in making their customers aware of their products. Printing of brochures, flyers or catalogues, and any advertising in magazines or newsletters. * Packaging Materials - When selling the products directly to the customer one need some sort of packaging material for them to carry their purchases home. This would include gift boxes, bags, tissue, hand tags, and gift cards. * Rent - If one were to rent a shop or studio the cost to rent, utilities, and cleaning supplies * Portfolio - The cost of building the portfolio whether one would do it their self or hire a professional to help. This includes photographic expenses as well, such as the cost of film and developing, duplicate slides and prints, hiring a professional photographer. * Selling Time - In the selling costs one must also consider not only the time one actually spend at the show sitting behind your booth, but the time spent packing up the jewelry the day before, loading the car, traveling time, unloading and unpacking when one get back — after all, one is losing these hours from production. * Sales Help - One may need to hire help for setting up and dismantling your booth, as well as help in selling. * Mail Order - If one sells their products through the web or mail order then one must also consider the mailing costs such as postage, shipping, and extra packaging materials.
Effect of Selling Costs (Advertising Expenditure) on Demand The purpose of advertising is to increase the demand, that is, to shift the demand curve for the product to the right. However these selling costs or advertising outlays are subject to the varying returns. That is, equal increments in advertising outlay first yield increasing returns and then eventually diminishing returns in terms of its effect on demand for the product. In the beginning increases in advertising outlay will bring about increasing returns in raising demand for the product for two reasons. First, increase in advertising outlay (or selling costs) permits a firm to repeat many times the advertisement for the product. And this repetition of advertisements produces favorable effects on demand. “It is well established that repetition is essential if advertising is to make an impact on the consumer’s mind. A single advertisement seen once will have at the most a negligible, and probably no effect on the consumer. The outlay for it is wasted. But continued advertising over a period of time and in different media is far more likely to impinge on the consumers’ thoughts consequent consumption choice”.
Second reason for occurrence of increasing returns as the advertisement outlay is increased in the beginning is the economies of large scale selling operations or advertising outlay. The main advantage is the specialization which is made possible by the large scale selling or advertising activity. To quote Prof. Hibdon again, “Large scale activities permit the use of specialized personnel with greater expertise and effectiveness. There may also be economies in the use of advertising media. Greater total spending permits a shift in the technique and media that are used in the selling effort as well as the use of combinations of media. As a result of the increasing returns from advertising outlay in the beginning, the demand increases more than proportionately to the equal increases in advertising outlay. The effect of selling costs on the demand for the product and the varying returns is illustrated in the following figure. Demand curve before any advertisement is undertaken is d0. Now, equal increments in advertisements expenditure successively bring about rightward shift in the demand curve to d1, d2, d3 and d4 respectively. We have assumed that the shift in the demand curve is parallel, while in the real world it may not be so. Because in the beginning there are increasing returns and then after a point diminishing returns occur successive shifts in the demand curve differ in magnitude. At the given price OP, as a result of equal increments in advertising outlay, the quantity demanded increases from q0 to q1, q1 to q2, q2 to q3 and q3 to q4. After d3, the diminishing returns to extra advertising outlay occur.

Increasing and decreasing returns to advertising expenditure or selling costs

The Curve of Average Selling Costs The concept of the curve of average selling costs should be carefully understood. When a firm has to plan what amount of advertising outlay (i.e., selling costs) it should incur we treat the selling cost as a variable magnitude. Thus with a certain amount of selling cost (advertising outlay) incurred in a period, the average selling cost or advertising cost per unit will depend upon the total output sold as a result of the rightward shift in the demand curve brought about by the amount of selling costs incurred and can be obtained from dividing the amount of advertisement costs incurred by the quantity of output sold. And as a firm plans to increase the amount of selling cost incurred in a period the average selling cost will change depending, on the one hand, upon the increase in selling costs and, on the other, upon the resultant increase in output demanded (or sold) at a given price. As explained, it is generally believed that selling costs (advertisement outlay) is subject to varying returns. In the beginning, increasing returns to the selling costs are obtained, that is, equal increases in advertisement outlay cause more than proportionate increase in the amount demanded of the product at the given price. In other words selling costs per unit of output will fall in the beginning. After a point diminishing returns to selling costs set in, increases in advertisement outlay would cause less than proportionate increases in the amount demanded of the product. In other words after point, average selling cost will rise. Hence, average selling cost in the beginning falls due to the increasing returns, reaches the minimum level and then rises due to the diminishing returns. Thus, the curve of average selling cost, like the ordinary average production cost curve, is u-shaped, which is shown in the diagram by the curve ASC. However, the average selling cost curve ASC drawn in figure should be carefully interpreted. It does not mean how the average selling cost per unit changes as output is increased. But it means the average selling cost per unit which is required to be undertaken to sell an extra unit of output. Ultimately, the average selling cost curve ASC will become vertical. This is because often the saturation point regarding the effect of extra selling costs on raising the demand for the product is reached, beyond which no further increases in selling costs causes any expansion in amount demanded of the product.

Average selling cost curve when total selling cost is treated as a variable

Optimum Level of Advertising Expenditure or Selling Costs when Both Output and Price are Variables Now, we shall explain the optimal level of advertising expenditure incurred by a monopolistically competitive firm to maximize its profits when it can influence both output and price through its advertising campaigns. In other words we will now explain the profit – maximizing or optimal combination of advertising expenditure, output and price. We shall make our analysis with a two dimensional diagram. It may be emphasized again that advertisements expenditure or selling costs are an important form of non – price competition. Advertising represents a method by which a firm can increase the sales of its product and is an alternative to reduction in price of the product for promoting its sales. A firm can increase its sales by lowering the price of its product. But when it thinks price cutting is not prudent, the firm may attempt to promote sales through its advertising campaign. However, through advertisement or other forms of selling costs, a firm can increase both its output and price of its product. It may be noted that cost on advertisement or other forms of sales promotion activities of a firm depends in part also on how much advertising expenses or selling costs are being incurred by the rival firms. Given the demand for the product of a firm and the amount of advertisement costs incurred by the rival firms, we get a U – shaped average selling cost curve which show due to the greater effect of advertising on increase in demand and output in the beginning as advertising expenditure is stepped up, the average advertising cost (that is, selling cost per unit of output) falls. Beyond a certain level of advertising expenditure diminishing returns to additional advertising set in causing a rise in selling cost per unit of output. We obtain the average cost curve (AC) inclusive of average selling cost by adding vertically the average production cost (APC) and average selling cost (ASC) curves. Note that the vertical distance between the average total cost curve (AC) and average production cost curve (APC) increases beyond a point due to the rise in the average selling cost following the occurrence of diminishing returns to the increase in advertisement expenditure. The choice of combination of advertising, output and price that maximizes the profits of the monopolistically competitive firm is illustrated in the figure below. We assume that in the absence of selling costs or advertising expenditure the demand for the product of the firm is given by the curve D0. On the other hand, in the absence of advertising, APC is the average production cost curve which as usual is U – shaped and MC is the marginal cost curve associated with it. Prior to any advertising costs the firm is in equilibrium by producing Oq0 level of output and charging price Op0 for its product. It will be seen that in this equilibrium situation prior to any advertising costs, the firm is making zero economic profits since price is equal to average costs, Now, in order to earn positive economic profits the firm will attempt to raise demand for its product by launching an advertising campaign to attract customers. As it steps up its advertising expenditure the demand curve for its product will shift to the right. On the other hand, on account of increasing amount of expenditure incurred on advertisement, his average cost curve inclusive of advertising cost per unit will also shift above. It is worth nothing that the average selling cost (that is, selling cost per unit of output) depends in part on the anticipated increase in output following the increase in demand for the product caused by expansion in advertising expenditure. Since in the present model we are treating selling cost as a variable magnitude, marginal cost curve will also shift upward due to the additional advertising costs incurred as shown by the new higher marginal cost curve MC1 which includes marginal advertising cost as well. Let us assume that after a certain magnitude of advertising expenditure has been incurred

Profit after Advertising

Optimum levels of Advertising, Output and Price

Long – Run Equilibrium of Firm with Advertising Expenditure

Long – Run Equilibrium with Advertising under Monopolistic Competition

Effect of Advertising (Selling Costs) on Elasticity of Demand As a result of advertising expenditure demand for the product increases, that is, demand curve shifts to the right. For the sake of convenience, it is to be that the new demand curves after successive increases in advertising expenditure is undertaken are parallel to the old one, though in actual practice they need not be so. However, in this connection it is useful to consider whether when the demand increases and demand curve shifts to the right, elasticity of demand at each price remains the same, declines or rises. The purpose of competitive advertising or other forms of selling costs are to influence the consumers to buy a particular brand than the other substitute brands of it. The intention of the producer who advertises for his brand of the product is to differentiate his brand more from the viewpoint of the consumers and try to prove his brand superior to others. Thus, if the purpose and intention of advertisements is achieved, then the consumers would begin to consider a particular brand of the product much superior to others. That is, they will now regard the other competitive brands as less closely substitutes than they were thinking before. This greater the degree of differentiation and consequently fall in the elasticity of substitution will cause a decline in the elasticity of demand at each price as the demand curve shifts to the right under the influence of the advertisement. It is therefore, likely that the elasticity of demand should decline under the influence advertising or other forms of selling costs. The extent to which elasticity will decline is of course very uncertain. Changes in the elasticity of demand as a result of advertising expenditure have great significant implications for price-output equilibrium.
Effect of Advertising (Selling Costs) on Price and Output The effect of advertising and other forms

GEORGE JOSEPH STIGLER

Problem of Advertisements & Selling Costs The third problem is the problem of advertisements and selling costs. The seller may influence the volume of his sales by making expenditures. of which advertising: may be taken as typical which are directed specifically to that purpose. Such expenditures increase both the demand for his product and hi, costs; (advertisement increase- the short- run costs and in the long-run. sometimes and generally. the revenue 100) and their amount will be adjusted as are prices and 'products' so as to render the profits of the enterprise maximum. The gains from this service are possible because of (a) imperfect know ledge on the part of the buyers as to the means where buy, wants may be most effectively satisfied and (b) the possibility of altering wants by advertising or selling appeal. Chamberlin distinguishes selling costs (which include advertisement costs) from production costs. The costs that must be incurred to make a product transport it and have it available: to the consumer with given wants are production costs. The costs of changing consumers want thorough advertisement or any kind of promotional activity is selling costs. It is to be noted that this selling cost factor is peculiar to monopolistic competition, since advertising would be without purpose under conditions of pure competition, where any producer can sell as much as he pleases, without it, These three major problems constitute the basic characters tic features of monopolistic competition.

Implication of Product Differentiation: Advertising
As mentioned above, monopolistically competitive firms differentiate their products in order to have some control over the price. In this case, the products are not perfect substitutes, and this makes the demand less than perfectly elastic. The implication of this is that some consumer won’t switch when the prices go up within a limit, while others are willing to switch. To keep the other consumers from switching to the substitutes, firms under monopolistic competition spend a lot of money on advertising. There are two kinds of advertising under monopolistic competition.
1) Comparative Advertising: This involves campaigns designed to differentiate a given firm’s brand from brands sold by competing firms. Comparative advertising is common in the fast–food industry, where firms such as McDonalds attempt to simulate demand for their hamburgers by differentiating them from competing brands. This may induce consumers to pay a premium for a particular brand. This additional value for a brand in the price is called brand equity.
2) Niche Marketing: Firms under monopolistic competition frequently introduce new products. The products could be totally “new” or “new improved”. Firms can also advertise a product that fills special needs in the market. This advertising strategy targets a special group of consumers. For example “green marketing” advertise “environmentally friendly” products to target the segment of the society that is concerned with the environment. The firm packages a product with materials that are recyclable.

BIBLIOGRAPHY http://simplestudies.com/ http://www.productivity.in/
Managerial economics h. l. ahuja page no 551-564 s.chand