This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, McGraw-Hill. Advertising and Disclosure  Informative Advertising  Persuasive Advertising  Maximizing Profit  Welfare 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, 4 th edition, McGraw-Hill. Source:

This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, McGraw-Hill. Information and Advertising  Promotions  Brand names  Search Goods  Experience Goods  Credence Goods

This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, McGraw-Hill. Persuasive Advertising  Explicit attempts to change your preferences  Examples?  Nelson (1974) 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, 4 th edition, McGraw-Hill. Profit Maximization in Advertising MC Quantity $ D (no ad) D (ad) What is the relationship between the extra expenditure on advertising and the increase in profitability? MR

This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, McGraw-Hill. Welfare Effects of Price Advertising  Price advertising tends to lower market prices 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, 4 th edition, McGraw-Hill. Advertising and the lemons problem  Assumptions 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, 4 th edition, McGraw-Hill. Excessive Advertising  Suppose an ad convinces you that buying an expensive cologne makes you more attractive. Are you better off? 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, 4 th edition, McGraw-Hill. Welfare effects of Advertising  Dixit and Norman (1978) 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 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, 4 th edition, McGraw-Hill. Profit Maximization in Advertising MC Quantity $ D (no ad) D (ad) MR D C B A

This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, McGraw-Hill. False Advertising  Why don’t all firms lie when advertising?  Nelson False claims are much more likely for experience goods than for search goods