Nowadays, advertising is a very big business. Very often is the major means of competing among firms. Furthermore, supporters of advertising claim that it brings specific benefits for consumers.
First off all, they claim that advertising provide information to consumers about the quality or the availability of several products. This is very important for consumers because they do not waste time for searching (search costs). If we suppose, that consumers want to shop at the lowest price shop but, they do not know which is the store with the lowest prices, then they gather information by reading and watching advertisements and TV commercials respectively or by visiting several stores. This action of consumers makes prices to fall, but only if consumers have the appropriate information. Otherwise the prices may rise. Supporters of advertising also claim that advertising may encourage price competition among the firms, if prices feature significantly in the advertisement. In addition to this, by increasing sales through advertising, firms can gain economies of scale, which means that it will help to keep prices down.
As we can understand information is very essential for consumers, not only because it lowers the prices, but also because it improves the quality of several products. The problem here is that it is unlikely for all the consumers to have perfect information. This means that the information is either imperfect or asymmetric. Imperfect information, as well as asymmetric information, lowers quality.
Advertising may solve this problem in most cases. Consumers can gather information for several products through advertisements and because of this, producers must improve the quality of their products. But why firms advertise so much? As I noted above advertising increases consumer’s information. So we can suppose that a firm which advertise much, has high quality products. A very expensive advertising campaign is something like a signal to potential consumers, that the firm believes that its product has good quality. Furthermore the company believes that because of its good quality products, is going to make repeat sales for a long time in order to “recoup the fixed costs of initial advertising”. On the other hand, firms with poor quality products “that know that consumers will soon discover they have been misled about quality”, do not invest much in advertising.
This is a very good source of information for consumers because in that way they can realize the difference between firms, which advertise much and firms which, do not advertise so much. It is one of the explanations of how advertising can improve consumer’s information about the quality of products.
In addition to this, there are some goods that have to be used for a very long time before their quality can be established by the consumers. “Consumers now have a lot to gain from truthful advertising, but lying advertisers could get away with it for quite a while”. Lying advertising called and “hit and run” advertising as well. This is a real problem for producers who know that their products are good. The only thing that they can do in order to overcome this difficulty is to raise the “stakes and commit a lot of money to advertising”.
It is easy to understand here, that this can make sense only if they expect their product to be successful for a very long time, long enough for the consumers to find out that the product is really good.
Furthermore, there are some goods that usually they are not going to be replaced for a decade or more (once-off purchase). The question that may arise here is how a consumer can discover the quality of such a good. In that occasion a producer who knows that his products are good, has no reason to advertise. So, as we can understand “a willingness to advertise no longer signals that the product must be in high quality”.
To sum up we can say that it is very common for producers who produced high quality products to advertise. The table below- taken from Carlton and Perloff textbook 2nd edition -indicates spending in advertising of tobacco.
Rank U.S advertising in 1990
($ thousands) Advertising as a Percent
of U.S sales
American Brands 49 277,084 4.8
Philip Morris 2 2,210,233 6.1
Philip Morris as well as American Brands, are major tobacco companies. As we can from the table, Philip Morris spent a very large amount for advertising, equal to 6.1% of its U.S sales.
As I noted above, advertising can improve consumer’s information the quality of several products. Consumers have the opportunity to collect information through any form of advertising in order to purchase only high quality goods. But is advertising always truthful and informative? The answer to this question is “no”. Advertising may sometimes be false and uninformative. Of course false advertising is illegal but firms can advertise in a false or a misleading manner for years. In order to stop this we can properly use Antifraud laws. Let’s take an example to understand better what Antifraud laws are. “Suppose that the law prohibits the misleading of the fabric content of clothing. If the law is always enforced, consumers believe that a clothing label is usually correct, thereby giving a manufacture an incentive to mislead. On the contrary, in the absence of any enforcement consumers do not trust clothing labels and as a result firms have little incentive to mislead”. (Statement taken from Carlton and Perloff)
The question that may arise here is if we have to enforce these laws or not. It is not so simple to answer this question. As I noted above we have to use Antifraud laws properly if we want to increase consumer’s information. This means that the optimal level of enforcement lies somewhere in the middle range between no enforcement at all and enforcement of those laws.
Furthermore we can use Disclosure laws in order to stop misleading advertising. This set of laws “require firms to reveal truthfully to consumers certain information about their products”.
It is quite easy then to understand that society would gain if uninformative or false information banned.
Finally, we can say that ‘skepticism’ by consumers discourages false or uninformative advertising. It is very important for the society to collect only the appropriate information about several products. In a world with informative advertising, goods are much better and producers as well as consumers gain more.
Modern Industrial Organization 2nd edition
Carlton & Perloff
The theory of Industrial Organization 5th edition
Economics 5th edition
Stanley Fischer & Rudiger Dornbusch
Positive Economics 8th edition
Lipsey & Chrystal
Word Count: 1057