4.6. Advertising that Might Not Inform 184
4.6.1 Too Much or Too Little Advertising: A Broader Perspective 185
4.6.2 Consumer Naivety 191
4.6.3 Advertising and Goodwill 194
4.6.4 Concluding Remarks 197
4.7. Closing Comments 198
Acknowledgments 200
References 200
Abstract
This chapter proposes an analysis of the role of advertising in the transmission of information in mar-
kets. It also describes how the economic analysis of informative advertising provides a satisfactory
account of advertising practices and discusses the extent to which resorting to alternative approaches
to advertising might be fruitful. In doing so, it provides an overview of what has been identified in the
literature as the main incentives of firms to resort to advertising as well as the main arguments pertain-
ing to the welfare economics of advertising. The chapter provides some simplified expositions of the
various theories and describes some related empirical literature. The exposition starts with a presenta-
tion of the analysis of informative advertising. It is first explained how the informative role of advertising
can be understood from the theory of search with particular attention to price advertising. Advertising
that contains direct product information is then considered, looking at the nature and the amount of
such information provided by advertisers and including some considerations on legal restraints on mis-
leading advertising. Finally, the argument that advertising may provide indirect information in the form
of quality signaling or as a coordination device is described and discussed. The chapter then moves on
to an analysis of the technology through which advertising conveys information to consumers, con-
sidering in turn advertising costs, targeting, and information congestion. The perspective is expanded
in the final part of the chapter by allowing advertising to have some role other than the transmission of
information. In doing so, the welfare implications of advertising are reconsidered while accounting for a
potentially persuasive role of advertising or viewing advertising as a good that complements the adver-
tised product in the consumer's preferences. The strict consumer rationality assumption is also relaxed.
The exposition ends with the dynamics of advertising resulting from its role in the accumulation of
goodwill for a product or a brand.
Keywords
Informative advertising, Persuasive advertising, Complementary good approach to advertising, Welfare
analysis of advertising, Consumer search, Product information, Information disclosure, Signaling
JEL Codes
D42, D82, D83, L11, L15, M37, M38
4.1. INTROD UCTION
As other chapters in this volume illustrate, advertising is a key ingredient of the media
business model. According to
Holcomb (2014), advertising revenue represented 69%
of total media revenue in the US in 2013, down from 82% in 2006. The magnitude
122 Handbook of Media Economics
as well as the evolution of this ad revenue share suggest that implications of the economics
of advertising are very relevant to the economics of media. In particular, they provide the
basis for interpreting the demand for advertising space, which in turn determines ad rev-
enue. Advertising is also a critical (though usually adverse) determinant of the attractive-
ness of a media outlet to its audience or readership. The nuisance experienced by a reader,
a listener, or a viewer, because of advertising, might be somewhat mitigated by the value
that the individual gets out of being reached by the ad. Again, understanding what adver-
tising does and how it affects the consumer helps analyze this mitigating effect. Finally, a
proper welfare evaluation of the media market should account for the impact of adver-
tising on the product market outcome.
In this chapter, I present an overview of the economic analysis of advertising.
Although the focus is mostly theoretical, I describe some empirical work, which is
directly relevant to the theoretical issues I am discussing. The presentation is organized
around the idea that a major function of advertising is to facilitate the dissemination of
information to buyers. My goal is to investigate how much can be understood about
advertising while considering that its sole function is to transmit information.
A complementary objective is to determine how much more can be learned from alter-
native views on advertising.
The motivation for emphasizing information transmission is twofold. First, due to the
considerable development of the economics of information since the 1960s, economic
theory is well suited to the analysis of information and its impact on the market outcome.
It provides a well-defined role for advertising that can be understood while viewing con-
sumers as rational decision-makers endowed with stable tastes. In particular, this allows
for standard welfare evaluations, on the basis of which policy implications can be dis-
cussed. This is why a large majority of the theoretical contributions in the last 50 years
concerns informative advertising. Second, even if there might be a debate about how
much of advertising is informative, there is no doubt that the market outcome cannot
be fully understood while abstracting from the informative role of advertising. It gets con-
sumers information that they would otherwise access at a very high cost or not at all. If
nothing else, it tells them about the availability of new products.
Although it might now seem natural that economists study informative advertising,
early writers on the subject mostly insisted on some other role.
Bagwell (2007) offers a
very comprehensive survey of these early works. Advertising is broadly described as a
wasteful activity that enhances a firm’s market power. Particular emphasis is put on its
role as an effective barrier to entry. One benefit of advertising that is usually acknowl-
edged by these authors is that, by increasing sales, it generates economies of scale. Some
relevant references are
Braithwaite (1928), Robinson (1933), and Kaldor (1950).
As
Bagwell (2007) explains, this strand of research may be gathered into what he calls
the persuasive view. According to this line of thought, advertising is for the most part a
manipulation of tastes as in
Braithwaite (1928), or a manipulation of information as in
123Advertising in Markets
Kaldor (1950) . This approach was quite prominent until the 1960s. It has in particular
contributed a large body of empirical work on the measure and determinants of market
power. Major contributors in this respect are
Bain (1956) and Comanor and Wilson
(1967, 1974)
. Although different authors propose different interpretations of how adver-
tising impacts consumer behavior, they all stress that it induces major economic ineffi-
ciencies by enhancing market power and creating barriers to entry. In particular, it
induces spurious product differentiation (
Braithwaite, 1928; Comanor and Wilson,
1967, 1974
).
Prior to the 1960s, several authors such as
Marshall (1890, 1919), Chamberlin (1933),
and
Kaldor (1950) had recognized an informative role for advertising. Notably
Chamberlin (1933) proposes an analysis of the use of informative advertising by a monop-
olistically competitive firm. He distinguishes advertising that informs consumers about
the existence of a product that has a market expansion effect and price advertising that
makes the firm’s demand more elastic.
Kaldor (1950) also considers that one of the roles of
advertising is to provide information about the price and the product. However, he views
this information as unreliable because it is provided by an interested party. In the end, he
concludes that advertising is mostly persuasive. When trying to assess the informational
benefit of advertising, these authors face a major difficulty: they analyze the impact of
better information for consumers in a theoretical setting that assumes that consumers have
perfect information about prices and products. One contribution of the informative view
is to propose some new theoretical frameworks and concepts that take into account con-
sumers’ imperfect information.
What
Bagwell (2007) characterizes as the informative view constitutes a complete flip of
perspective from the persuasive view regarding the impact of advertising on economic
activity. Advertising is considered in this alternative approach as enhancing competition
and economic efficiency by providing consumers with better information about the
competing options. Rather than being a barrier to entry, it facilitates it and rather than
softening competition by introducing more product differentiation, it intensifies it by
facilitating price comparisons.
1
It should be no surprise that this line of reasoning is asso-
ciated with the Chicago School. The two seminal theoretical contributions to this liter-
ature are
Stigler (1961) and Nelson (1974). They constitute the main inspirations for this
chapter (
Sections 4.2–4.4) and I return to them repeatedly.
2
In his grandiose introductory paragraph, Stigler (1961, p. 213) makes the point that, of
all people, academics should realize that “… information is valuable: knowledge is power.
And yet it occupies a slum dwelling in the town of economics.” In the same paragraph,
he moves on to write “And one of the information producing industries, advertising, is
treated with a hostility that economists normally reserve to tariffs or monopolists.”
1
The influential work by Telser (1964) illustrates these ideas. See Bagwell (2007) for details.
2
See also Ozga (1960) for an early theoretical contribution on informative advertising.
124
Handbook of Media Economics
The foremost contribution of Stigler’s article is to offer the first analysis of consumer
search for a low price in a market where prices are dispersed. This then sets the stage
for thinking of advertising as facilitating the consumers’ access to information. Stigler
has a first crack at such a study of informative advertising by considering that it increases
the number of options a consumer is aware of and hence can choose to search through.
Although
Stigler (1961, p. 213) does mention “… the relationship of commodities to
consumer preferences …” as a relevant dimension about which we should suspect there is
imperfect information, his analysis is solely focused on prices. By contrast, Nelson’s
renowned 1970 article investigates how consumers have access to product information.
A fundamental insight from Nelson’s investigation is that, contrary to price information,
product information is not entirely accessible through consumer search. Some attributes,
the experience characteristics, such as the taste of some food product, can be learned only
after the product has been purchased. He introduces the distinction between search goods
that the consumer can essentially evaluate through search and experience goods for which
experience constitutes the main source of information.
Nelson draws the main implications of this distinction for advertising in
Nelson
(1974)
. He argues that much of the information transmitted through advertising is indi-
rect and that this is especially the case when advertising concerns experience goods.
Nelson further explains that this should lead to large advertising expenditures for expe-
rience goods (see
Section 4.4), along with ads for search goods that include a lot of direct
information (see
Section 4.3). He gathers some empirical evidence in support of this
view. Nelson’s point is primarily to argue that advertising provides indirect information,
but he also makes a number of very valuable remarks and conjectures about the provision
of direct information through advertising.
Although the informative view affords a powerful explanation for how advertising
impacts consumer behavior and contributes to social welfare, it is quite conceivable that
advertising that has no informative content is also an effective and socially useful activity.
Chicago School economists have put forward standard microeconomics to argue that
advertising may be viewed as yet another commodity which can be supplied efficiently
by a competitive economy.
This alternative approach to advertising is described by
Bagwell (2007) as the comple-
mentary view. The gist of the argument is that advertising may be thought of as a com-
plementary good to the advertised products. The increase in willingness to pay
induced by advertising merely reflects the benefit the consumer draws from consuming
this complementary good along with the purchased product. The idea that advertising
should be viewed as a commodity had already been considered in the analyses of
Kaldor (1950) and Stigler (1961). But the first systematic analysis of advertising along
those lines is due to
Stigler and Becker (1977). Other important contributions are
Nichols (1985) and Becker and Murphy (1993).AsBagwell (2007) points out, a key dif-
ference between the complementary view and the persuasive view is that, in the former,
125Advertising in Markets
consumers are endowed with stable preferences whereas in the latter advertising may
induce a change in these preferences. I discuss the implications of these various interpre-
tations in
Section 4.6.
I hope to show through this chapter that a lot can be learned about advertising while
keeping a strict informative perspective. In particular, I show that the opposition between
a persuasive view that stresses how advertising adversely affects economic efficiency and
an informative view that emphasizes the contribution of advertising to social welfare is in
part unfounded. Even if advertising is merely used to provide information, it can be to a
large extent a waste of resources used in a combative manner by firms to take over each
other’s market share. It can also contribute to enhance market power by improving con-
sumer awareness of differentiation among products.
Still, the informative view has its weaknesses. It involves great strategic complexity.
As a result, it assumes a lot in terms of consumer sophistication and leads to some inde-
terminacy in the form of multiplicity of equilibria. It overemphasizes the advertising of
prices, which does not seem to mesh well with much of the advertising we see. It also
seems better suited to explain advertising for new products rather than advertising for
established brands. This is why alternative approaches that incorporate uninformative
content or allow for some consumer naivety should not be overlooked despite the many
conceptual difficulties and controversies they entail.
Before outlining the remaining content of this chapter, I should mention two very
recent literature reviews that cover similar material. I have already repeatedly referred
to
Bagwell (2007) that offers a very comprehensive overview of the economics of adver-
tising. In particular, it provides a very detailed discussion of the empirical literature over
the years. I have drawn on it substantially to write this chapter. My goal, however, has
been to propose a somewhat narrower perspective that complements the work of
Bagwell (2007). One important difference is that I stress the link between search and
advertising (in
Section 4.2). I also cover a number of recent contributions that came
out after 2007, in particular some research pertaining to product information disclosure,
discussed in
Section 4.3.4. Another recent survey is Dukes (2006), who offers a succinct
overview of the main issues, with particular attention to how advertising interacts with
competition.
Each of the following sections in the chapter ends with some concluding remarks that,
whenever relevant, highlight some implications for media economics. The next three
sections are devoted to the analysis of informative advertising.
Section 4.2 explains
how the informative role of advertising can be understood from the theory of search.
It also discusses the main contributions and issues concerning price advertising.
Section 4.3 concerns advertising that contains direct product information. It first discusses
the literature on the role of advertising in matching horizontally differentiated products
to consumers and then considers the strategic disclosure of product attributes by firms.
Section 4.4 presents the vast literature inspired by Nelson’s argument that much of
126 Handbook of Media Economics
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