Advertising and Disclosure
Informative Advertising
 Persuasive Advertising
 Maximizing Profit
 Welfare
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Price Advertising
The Lemons Problem
Excesses
Ads as a barrier to entry
False Advertising
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Source:http://adage.com/images/random/lna2007.pdf
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Information and Advertising
Promotions
 Brand names
 Search Goods
 Experience Goods
 Credence Goods
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This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Persuasive Advertising
Explicit attempts to change your
preferences
 Examples?
 Nelson (1974)
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Advertising/Sales ratios are 3 times greater for
experience goods than for search goods.
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Profit Maximization in Advertising
$
What is the relationship between the
extra expenditure on advertising and the
increase in profitability?
D (ad)
MC
MR
D (no ad)
Quantity
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Welfare Effects of Price Advertising
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Price advertising tends to lower market
prices
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Apply the tourists and natives model
Benham (1972) eyeglass ads about price
lowered prices across states
Kwoka (1984) price advertising may cause
prices to fall and quality to fall as well
Professional Organizations and Advertising
restrictions
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Advertising and the lemons problem
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Assumptions
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Consumers can find out about quality only by
consuming the good
Marginal and average costs of production are
the same for high and low quality goods
Ads can signal product quality
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Excessive Advertising
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Suppose an ad convinces you that buying
an expensive cologne makes you more
attractive. Are you better off?
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Pre-advertising tastes
Post-advertising tastes
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
Welfare effects of Advertising
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Dixit and Norman (1978)
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A small increase in advertising raises welfare only if
firms find it profitable. There cannot be too little
advertising.
Reducing advertising from the profit maximizing level
raises Welfare
Criticism of this result
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May want to use pre-advertising preferences before ads
and post advertising preferences after—Especially when
the ads promote a change in quality (Fisher and
McGowan 1979)
If the advertisements serve to inform consumers that
the product exists, we may get too little advertising
(Shapiro 1980)
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.
False Advertising
Why don’t all firms lie when advertising?
 Nelson
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False claims are much more likely for
experience goods than for search goods
This slideshow was written by Ken Chapman, but is substantially based on concepts from
Modern Industrial Organization by Carlton and Perloff, 4th edition, McGraw-Hill.