The analysis of targeted advertising has remained rather limited. The key role played
by the media who specialize in reaching a certain type of audience is usually acknowl-
edged, but generally abstracted from in the analysis. It is often argued that the Internet has
great potential for capturing a larger share of the advertising market, not only because of
the breadth of the advertising reach it offers but also because of the quality of that reach,
thanks to the improved targeting facilitated by the large amount of information gathered
on users. How profitable this may be depends, however, on how the profitability of
product markets is affected by this improved targeting. Some additional work would
be warranted that looks at this issue while taking into account the specificities of the
new targeting methods available such as keywords on search engines, tracking technol-
ogies, or exploitation of user-generated contents.
Finally, information congestion has important implications for the media business
model, by introducing a new externality among advertisers or among platforms (see
Anderson et al. (2015) for a theoretical analysis and Choi (2014) for an empirical
investigation).
4.6. ADVERTISING THAT MIGHT NOT INFORM
In all the preceding material, I keep with a strict informative interpretation of advertising.
As explained in the introduction, my goal is to explore how far this approach takes us in
our understanding of the role of advertising in markets. The present section extends the
scope of the analysis by considering some roles for advertising that are not necessarily
associated with the provision of information to consumers. As can be seen from
Sections 4.3 and 4.4, information transmission provides a rich framework for interpreting
advertising, even if it contains only limited information. Still, it requires that consumers
are very sophisticated and also leads to a great multiplicity of equilibria. Besides, it may
seem difficult to argue that massive advertising by well-established brands only has to do
with informing consumers. Furthermore, if advertising is about transmitting information,
it is not easy to explain why firms would not use it massively to provide price information,
especially if they are facing some competition. In practice, many ads do nor include any
price.
60
Here I first reconsider the welfare analysis of advertising without restricting
attention to informative advertising. I then discuss two forms of consumer naivety.
Finally, I consider the goodwill effect of advertising with particular attention to whether
it can be interpreted as evolving consumer information.
60
There are practical reasons why price information is not disclosed in ads: it may be too complex if it
involves price discrimination or a national brand may not wish to commit to prices so they can be set
locally and adjust to local conditions.
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Handbook of Media Economics
4.6.1 Too Much or Too Little Advertising: A Broader Perspective
I now consider a very simple problem, which I use to discuss the welfare implications of
advertising. Consider a monopolist charging a uniform price that can spend money
on advertising to shift its demand outward.
61
A first question concerns the contribution
of advertising to social surplus. There is actually a simple unambiguous answer to this
question, which is consistent with pretty much any interpretation of the impact of
advertising on demand that can be found in the literature. Indeed, the monopoly quantity
without advertising is typically below the socially optimal level calculated with the
demand curve with zero advertising expenditure. Hence, even if advertising shifts
demand while being completely irrelevant to the welfare of consumers, it may still
improve social surplus if it induces an increase in the quantity that the firm chooses to
produce and this increase in quantity is not too large so quantity remains below its socially
optimal level. For instance,
Glaeser and Ujhelyi (2010) use this argument in a context
where advertising is pure misinformation that convinces consumers that the product’s
quality is better than it actually is (or, in the case of cigarettes, which is their main appli-
cation, that the adverse effects of the product are milder than they really are).
62
As the
following discussion shows, this social benefit of advertising is even larger for the alter-
native welfare benchmarks that have been considered in the literature.
Advertising being socially beneficial does not mean that it is provided optimally by the
market. To address this issue, consider the following simple setting. A monopoly firm
with constant marginal cost c 0 sells to at most two consumers. Consumer i,
i ¼1, 2, has unit demand with reservation value r
i
A
ðÞ
> c, where A denotes advertising
expenditures by the firm and r
i
is strictly increasing in A . To simplify, assume the firm
chooses between A ¼0 and A ¼1.
I now present a welfare analysis of the firm’s choice to advertise that abstracts from any
informative role of advertising. A first approach, and in some sense a natural starting
point, is to assume that if advertising increases a consumer’s willingness to pay, it increases
the surplus she can obtain by consuming the product at some given price. The social ben-
efit of advertising should then incorporate the increase in consumer valuations. It is as if
advertising imparts a higher quality to the product. As noted by
Becker and Murphy
(1993)
, the welfare analysis is then similar to that of Spence (1975) regarding a firm’s
choice of its product’s quality (see
Tirole, 1988, chapter 2, subsection 2.2.1 for an analysis
of the choice of quality by a monopolist). The second-best social optimum prescribes that
61
This is what Johnson and Myatt (2006) call “hype,” which has been the main focus of the literature and
may be attributed to information or other forms of product promotion. They contrast it with advertising
that “rotates” demand, which they call “real information” in reference to the match information disclo-
sure discussed in
Section 4.3.3.1 . Match information typically turns some consumers away from the prod-
uct, whereas Johnson and Myatt presume that this would not be the case for non-informative forms of
advertising.
62
They actually derive the result for a Cournot oligopoly, where the argument is the same as for monopoly.
185
Advertising in Markets
the product’s quality should maximize the social surplus generated by the sale of the
monopoly quantity. This social surplus depends on the impact of quality on consumer
valuations for all the units sold. By contrast, the monopolist cares about the impact of
quality on its profit. This in turn depends on the impact of quality on the marginal con-
sumer’s valuation, which determines the monopoly price. Then, simple calculations
show that the profit-maximizing quality is below (respectively above) the socially optimal
one if the marginal impact of quality on the marginal consumer’s valuation is below
(respectively above) the marginal impact of quality on the average valuation taken over
all units sold by the firm.
In the simple two-consumer setting above, assume that with or without advertising,
the firm sells to both consumers.
63
Further assume that r
2
AðÞr
1
AðÞ, so consumer 2 is
always the marginal consumer and the firm prices at r
2
(A), A ¼0, 1. The firm chooses to
advertise if and only if 2 r
2
1ðÞcðÞ2 r
2
0ðÞcðÞ¼2 r
2
1ðÞr
2
0ðÞðÞ1. In contrast,
advertising is socially optimal if r
1
1ðÞ+ r
2
1ðÞ2c r
1
0ðÞ+ r
2
0ðÞ2cðÞ¼
r
1
1ðÞ+ r
2
1ðÞr
1
0ðÞr
2
0ðÞ1. Hence if the average change in valuation
r
1
2ðÞr
1
0ðÞ+ r
2
1ðÞr
2
0ðÞðÞ=2 exceeds (respectively is below) the change in valuation
for consumer 2 r
2
1ðÞr
2
0ðÞ, then the firm may under-advertise (respectively over-
advertise) as compared to the social optimum.
Arguably, the above result reflects the inefficiency of imperfectly competitive markets
rather than some specific property of advertising.
Stigler and Becker (1977) present a
model of consumer behavior on the basis of which they argue that the appropriate
approach to advertising is to view increases in willingness to pay as genuine increases
in consumer welfare. They develop a framework where households consume some com-
modities that they produce using various ingredients. Advertising is viewed as an ingre-
dient which is used, along with the advertised product, to produce such a commodity.
Advertising is therefore complementary to the advertised product. The main insight from
their analysis is that advertising may then be provided by perfectly competitive firms. The
idea is that there is perfect competition in the market for the commodity consumed by
the household. Such a commodity could, for instance, be “prestige” and the products that
might help produce it might be expensive watches or expensive shoes. The price on that
market is a shadow price that reflects the marginal consumer’s willingness to pay for one
more unit of the commodity. Firms competing on that market may charge different
prices if they provide more or less advertising, but the shadow price paid by the house-
hold is independent of which firm provides the product.
In the Stigler and Becker world, households can purcha se any quantity they wish of the
commodity at the equilibrium shadow price, independent of the firms’ advertising decisions.
This means that a firm’s decision to advertise does not affect consumer surplus. Advertising
may, however, enhance the firm’s revenue. For instance, in the two-consumer example,
63
The result can accommodate a change in the quantity sold if quantity adjusts continuously.
186
Handbook of Media Economics
if consumer 2 is the marginal consumer, then the equilibrium price is r
2
(0). By using adver-
tising, the firm may increase its revenue by 2 r
2
1ðÞr
2
0ðÞðÞand it chooses to advertise if this
is larger than 1. Because this has no impact on consumer surplus or on the producer surplus
of competitors, this rule is also optimal from a social surplus perspective.
Nichols (1985)
shows that if the commodity market is perfectly competitive, then the equilibrium adver-
tising expenditure is socially optimal.
Although the complementary view seems like the natural approach that is consistent
with the standard microeconomics of consumer behavior, many economists consider that
much of advertising induces some consumer response that can only be attributed to some
form of “irrationality.” This is what I have described in the introduction, following
Bagwell (2007), as the persuasive view. Still, there are two ways of interpreting the
increase in willingness to pay that advertising triggers. A first interpretation is that it is
pure manipulation that changes consumer behavior but not consumer tastes. This is,
for instance, explicitly the case in
Glaeser and Ujhelyi (2010), where advertising is pure
misinformation. This is also coherent with the analysis of advertising by
Braithwaite
(1928)
or Kaldor (1950). Social welfare should then be evaluated using the
no-advertising valuations, r
i
(0), i ¼1, 2, in my two-consumer example.
But the persuasive view has often been portrayed as considering advertising as a taste
shifter (see
Bagwell, 2007, p. 1720). For instance, Stigler and Becker (1977, p. 83) cite
Galbraith (1958), who writes that advertising’s “… central function is to create desires—
to bring into being wants that previously did not exist”. In a very influential and contro-
versial article,
Dixit and Norman (1978) undertake a welfare analysis of advertising that is
consistent with this point of view. Because tastes change as a result of the firm’s adver-
tising, it is unclear which preferences should be taken into account to establish the welfare
benchmark. Either the new preferences are treated as irrelevant to welfare and then the
analysis should proceed assuming advertising only induces a change in behavior, so the
original valuations should be used to compute social welfare. Or we should acknowledge
that this change in tastes defines a new welfare criterion and the post-advertising valu-
ations provide the proper welfare measure to compare the market situation with and
without advertising.
Dixit and Norman (1978) consider both possibilities and establish
a remarkable over-provision result, which holds independent of which welfare measure
is selected.
I now present the gist of Dixit and Norman’s argument using the two-consumer
monopoly setting. Assume that, without advertising, the firm only serves consumer 1,
whereas if it advertises it serves both. This increase in quantity ensures that there is some
social benefit associated with advertising. Otherwise, advertising would clearly be exces-
sive if the firm chose to resort to it. Further assume that r
2
1ðÞr
1
1ðÞso that consumer 2 is
the marginal consumer if the firm advertises. The firm’s surplus is therefore r
1
0
ðÞ
c if it
does not advertise and 2 r
2
1ðÞcðÞ1 if it does. Advertising thus generates the incre-
mental producer surplus 2r
2
1ðÞr
1
0ðÞc 1. Using the post-advertising tastes, the
187Advertising in Markets
incremental social welfare induced by the firm’s advertising is the social surplus associated
with the purchase of the product by consumer 2 minus the advertising cost r
2
1ðÞc 1.
It is readily seen that the incremental producer surplus exceeds the incremental social
surplus if and only if r
2
1
ðÞ
> r
1
0
ðÞ
. Because the firm charges consumer 1’s valuation
r
1
(0) if it does not advertise and consumer 2’s valuation r
2
(1) when it does advertise, this
simple analysis shows that advertising is excessive if it induces a strict increase in monop-
oly price. Clearly, the result holds all the more if pre-advertising tastes are used instead to
evaluate welfare.
The incremental analysis above underscores the analysis in
Dixit and Norman (1978),
which uses continuous demand curves (see
Bagwell, 2007, subsection 4.2.1, for a graphical
illustration of the argument). The idea is that, when it advertises and serves an additional
consumer, the firm is capturing the entirety of the social surplus of the additional consumer
it serves and if, in addition, it increases its price, it is also capturing additional surplus from
inframarginal consumers. However, this argument is correct only as long as the additional
consumer who is served is also the marginal consumer that determines the post-advertising
price. This point is noted by
Shapiro (1980) in a clever comment on Dixit and Norman.
When using the post-advertising demand to perform their welfare analysis, they implicitly
assume that the order of consumer valuations has not been modified by advertising. In the
example above, assume to the contrary that r
1
1ðÞ< r
2
1ðÞso that, when it advertises, the
firm charges r
1
(1). The social surplus generated by advertising is still r
2
1ðÞc 1 and
price is still increasing, although now from r
1
(0) to r
1
(1). However, the incremental
profit is now 2r
1
1ðÞr
1
0ðÞc 1. If advertising only has a limited impact on consumer
1sor
1
1ðÞr
1
0ðÞis small, then the firm’s gain from advertising is less than the social value
it generates. Advertising may therefore be undersupplied by the firm even though it
induces an increase in the monopoly price. Obviously this is not the case if social surplus
is measured using the advertising-free valuations r
1
(0) and r
2
(0).
From the analysis above it appears that the only case where the welfare analysis of
monopoly advertising is unambiguous is when the impact of advertising on demand is
considered completely irrelevant to welfare so the advertising-free valuations are used
to evaluate surplus. In that case, the monopolist advertises excessively. It is not so surpris-
ing that, in the other cases, welfare results are not clear-cut, because both the persuasive
approach and the complementary good approach put little structure as to the impact of
advertising on inframarginal valuations as opposed to its impact on the marginal valua-
tion. I now conclude this discussion with some remarks on how the informative view of
the previous sections could be put to bear to evaluate welfare in this monopoly adver-
tising problem.
Here I consider in turn advertising reach, discussed in detail in
Section 4.2, and the
advertising of product information, studied in
Section 4.3. Recall that in the advertising
reach analysis pioneered by
Butters (1977), advertising expands a firm’s demand by mak-
ing more consumers aware of the firm’s existence, and that awareness implies that the
188 Handbook of Media Economics
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