Question

advertisements on social welfare​

Answer 1

While small businesses primarily use advertising to deliver information on their products and services, advertising methods also raise awareness of social issues. Powerful images, resonant music and well-worded text can evoke feelings in viewers to promote societal changes.

Answer 2

Answer:

Abstract

Analysis of the welfare effect of advertising depends critically upon the effect of advertising on market prices. In many circumstances, advertising that leads to higher (lower) market prices is overproduced (underproduced) from society’s perspective. This paper demonstrates that these predictions may not hold when consumer search costs are important. A model is developed to show how advertising affects equilibrium prices, search costs, and social welfare in monopoly and imperfectly competitive markets. When informative advertising leads to a sufficient reduction in consumer search costs, both consumer and producer welfare may increase even though market prices rise. This conclusion has important implications for policy analysts, because it demonstrates that one cannot test the welfare effect of advertising by determining the impact of advertising on market prices alone. One must investigate the impact of advertising on both market prices and search costs to fully understand the welfare effect of advertising.

Introduction

Debate about the social desirability of advertising has a long history and is characterized by very polarized positions. In the economics literature, Chamberlin (1933, pp. 119–120) argues that advertising may increase demand “by altering wants themselves”. This is a manipulative form of advertising as it exploits “the laws of psychology” with which the consumer “is unfamiliar and, therefore, against which he cannot defend himself…” McFadden and Train (1996) define this as a form of persuasive advertising that changes consumer tastes or beliefs about the product without changing the actual product characteristics themselves. In their classic work, Dixit and Norman (1978) argue effectively that when advertising changes tastes, any resulting increase in consumer surplus is illusionary and, therefore, should not be included in welfare calculations.1

Of course, not all forms of advertising are detrimental to society. Stigler, 1961, Telser, 1964 contend that advertising can provide useful information, which leads consumers to lower priced products with more preferred characteristics. In addition, Nelson, 1974, Milgrom and Roberts, 1986 show that advertising can signal quality in markets for search goods.

More recent research has investigated how specific types of advertising affect market equilibria. For example, Stahl, 1994, Bester and Petrakis, 1995 identify conditions under which firms in an oligopoly setting choose pure and mixed strategies in price and advertising. Regarding informative advertising, Stegman, 1991, Hernandez-Garcia, 1997, LeBlanc, 1998 investigate the impact of informative advertising when firms advertise in several media, use targeted advertising, and use advertising that reaches all consumers at a fixed cost. For purely persuasive advertising, Von der Fehr and Stevik, 1998, Bloch and Manceau, 1999, Tremblay and Martins-Filho, 2001, Tremblay and Polasky, 2002 determine the effect on market prices of advertising that changes consumer perceptions about horizontal and vertical product differentiation.

Previous research shows that the welfare effect of advertising hinges on the impact of advertising on market price and the extent to which advertising changes consumer tastes.2 In their pioneering work, Dixit and Norman (1978) demonstrate that the market will oversupply advertising when it leads to a higher market price and does not directly increase consumer utility. When it provides direct benefits to consumers or generates positive externalities, Becker and Murphy (1993) show that advertising will be undersupplied in the marketplace when it leads to a lower market price.3

In contrast to these studies, our analysis shows that there may be too little advertising from society’s perspective – even when advertising leads to a higher market price, has no direct effect on consumer utility, and generates no externalities. This can occur in markets where consumers face high search costs that are mitigated by informative advertising. The distinguishing feature of our model is that the consumer price (or full price) equals the producer (or market) price plus the unit cost of search for information needed by the consumer to make an informed demand decision. This might include information about price, product characteristics, and seller location. In this framework, search costs act like an excise tax that creates a deadweight loss by driving a wedge between the consumer price and the producer price. Our analysis shows that the market may undersupply advertising from society’s perspective when it leads to a sufficient reduction in search costs.