strictly better off telling the truth). In terms of modeling, this can be captured by
considering a product located on a circle sold to a consumer whose type is a location
uniformly distributed around that circle and the match is decreasing in the distance
between the locations. Then all product types have the same full information demand
and the firm cannot benefit from misrepresenting its type.
Chakraborty and Harbaugh
(2014)
use a related argument in a random utility discrete-choice model with random
coefficients. In their setting, a firm may credibly claim that one of its attributes is very
attractive to consumers (puffery about the best sandwich in the world) because by doing
so, it induces some adverse anticipations about some other attribute (the sandwich is not
very healthy).
40
With an experience good, the firm’s expected profit only depends on the buyer’s
beliefs about the firm’s type. Hence a necessary condition for information to be credibly
revealed through cheap talk is that expected profit is constant across all equilibrium beliefs
of the buyer (abstracting from the potential benefits from repeat purchases that
Nelson,
1974
factors in). Chakraborty and Harbaugh (2010) provide a general argument for the
existence of an equilibrium where cheap talk affects the consumer’s beliefs, when the
relevant information is multidimensional. For instance, if the match is given by
rt, sðÞ¼t
1
t
2
s, where the firm’s type is t ¼ t
1
, t
2
ðÞ21=2ðÞ,1½0, 1½and the con-
sumer’s type is s 2 0, 1½, then announcing t
1
, t
2
ðÞ¼1, 0ðÞyields the largest profit. Still,
there is a cheap-talk equilibrium where some partial information is credibly revealed.
4.3.5.2 Imperfect Enforcement of Laws on Misleading Advertisements
In his discussion of deceptive advertising,
Nelson (1974) writes: “There is another impor-
tant source of misleading advertising: the law” (p. 749). This provocative statement
reflects the idea that laws against misleading ads improve the consumer’s confidence
in the content of an ad, which in turn increases the incentives of advertisers to make false
claims (provided the law is not enforced with enough vigor). If enforcement is perfect,
then the analyses of
Sections 4.3.3 and 4.3.4 apply. I now discuss some recent research on
legal restraints on advertising that do not necessarily dissuade deception. I focus more
specifically on situations where some ads involve some actual false claims and yet are
partially informative, so the outcome could not be reached without advertising.
41
40
Anderson and Renault (2006) and Koessler and Renault (2012) provide other examples with a random
match that allow for credible disclosure, although they abstract from credibility issues by assuming perfect
certification.
41
For instance, Barigozzi et al. (2009) consider an imperfectly enforced ban on false comparative advertising
claim. However, their focus is on how such a law allows an entrant to signal it is high quality so in equi-
librium there are no false claims. Similarly,
Corts (2013) distinguishes laws on false claims and laws on
unsubstantiated claims (that are not supported by some evidence, which is costly to generate for the firm),
but also focuses on separating equilibria.
163
Advertising in Markets
Following Rhodes and Wilson (2014), consider a monopolist selling a product whose
quality is either high or low. The firm knows its quality and may claim that it is high to the
consumer who is initially uninformed. Making such a claim when quality is low, how-
ever, involves some penalty. Assume the consumers demand is price sensitive so she
retains some strictly positive surplus at the monopoly price. For intermediate values of
the penalty, there is an equilibrium in which the low-quality firm makes a false claim
with some probability strictly between 0 and 1. The consumer therefore updates her
beliefs when observing a quality claim and is charged a price derived from the corre-
sponding expected quality. However, at this price, the consumer pays too much for
the good whenever the actual quality is low. Still,
Rhodes and Wilson (2014) provide
a range of demand and parameter conditions where the consumer may actually benefit
from the existence of such false advertising and hence prefer a more lenient law enforce-
ment. This is because in those cases, such as when the product qualities are sufficiently
high, the deterioration in the expected quality associated with a high-quality claim is
more than compensated by a lower price.
42
Drugov and Martinez (2012) consider the choice of a communication strategy
by a firm that is assumed to be able to manipulate the signal that the consumer receives
about her match. Contrary to the match disclosure settings of
Section 4.3.3, the firm
may choose to bias that information to make it more favorable. However, increasing
that bias makes it more likely that the firm will be prosecuted and fined. The firm also
chooses the accuracy of a signal: a more vague signal makes the biased information less
reliable for the buyer but decreases the probability of prosecution. It is found that in the
optimal communication strategy, more bias is associated with more noise. In particular,
there will be more bias and more noise if the standard of proof required to prosecute
is higher.
Note that although these models explain why advertising might be misleading (in the
sense that the firm uses false information in its ad), they do not involve any consumers that
are systematically misled. In
Rhodes and Wilson (2014), consumers understand that a
high-quality claim might be sent by a low-quality firm and reduce their willingness to
pay as a consequence, while in
Drugov and Martinez (2012) they correctly anticipate
the bias in equilibrium. Although they are sometimes induced to make choices they
would not have made had they been perfectly informed, this is not any different from
what happens in other models I have discussed where the equilibrium is not fully reveal-
ing. As
Nelson (1974) points out, “Deception requires a misleading […]statement, but
also somebody ready to be misled by that statement” (p. 749). Assuming fully rational
consumers seems to keep the second requirement out of reach. I discuss the possibility
that consumers are somewhat less sophisticated in
Section 4.6.2.
42
Piccolo et al. (2015) find similar results in a somewhat related duopoly setting.
164
Handbook of Media Economics
4.3.6 Concluding Remarks
In addition to facilitating consumer awareness of available sellers and available prices for a
commodity, advertising can help consumers figure out the nature and characteristics of
the various products available for sale. Although information about search goods is avail-
able prior to purchase, it comes at a cost. Advertising then can provide some information
that lures consumers into incurring that cost. For experience goods, consumers cannot
decipher product information before buying without the help of the seller, who may
choose to use advertising to provide such help.
A common perception, supported by some evidence, is that advertisements contain
little information. This, however, does not mean that advertising is not about informa-
tion. Even if a firm may convey credible information at no costs to consumers, it may find
it more profitable not to do so or rather to use advertising to transmit a limited amount of
information. In particular, a firm whose product is a priori perceived as having high quality
finds it profitable to keep quiet about its horizontal attributes. This is the case whether the
product is a search good or an experience good. Still, there are configurations of tastes and
product attributes for which a firm reveals full information. This is the case in particular
when the only relevant information is quality.
More product information in advertising typically enhance the firm’s market power
and is associated with larger prices. Match information is used by the firm to target con-
sumers with high valuations for its product. In a competitive setting, more horizontal
match product information improves consumer awareness of product differentiation,
which softens price competition. This prediction that firms use advertising to enhance
their market power is consistent with the persuasive view, although here advertising is
purely informative.
Although laws against misleading advertising lend credibility to the information pro-
vided, they are not applicable to all pieces of information because they might not be per-
fectly verifiable by a court and law enforcement might remain sufficiently lenient that
false claims are not deterred. Recent work on cheap talk shows that, even if no misleading
ad law is in place, advertisers can sometime convey credible direct information. As sur-
mised by
Nelson (1974), this credibility is easier to achieve for search goods. Analyzing
how rigorous law enforcement should be is an important policy question that economists
have only recently started to address.
I have for the most part left aside welfare considerations in my discussion of product
advertising. Theoretical results are not at all conclusive as to whether firms provide too
much or too little information and whether forced disclosure rules might be desirable.
Still, withholding information often improves their ability to capture consumer surplus.
43
Forced disclosure laws may therefore be useful tools for consumer protection.
43
This is all the more the case if, rather than a posted price, the firm uses an optimal mechanism that elicits
the buyer’s private information, as shown by
Koessler and Skreta (2014) and Balestrieri and Izmalkov
(2012)
.
165
Advertising in Markets
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