Chapter 28
`
`THE ECONOMIC ANALYSIS OF ADVERTISING
`
`KYLE BAGWELL
`Columbia University
`
`Contents
`
`Abstract
`Keywords
`1. Introduction
`2. Views on advertising
`2.1. Setting the stage
`2.2. The persuasive view
`2.3. The informative view
`2.4. The complementary view
`2.5. Summary
`2.5.1. Combative advertising
`2.5.2. Persuasion and consumption distortions
`2.5.3. Joint supply
`2.5.4. Brand loyalty, advertising scale economies and market power
`3. Empirical regularities
`3.1. The direct effects of advertising
`3.1.1. Sales
`3.1.2. Brand loyalty and market-share stability
`3.1.3. Advertising scale economies
`3.2. The indirect effects of advertising
`3.2.1. Concentration
`3.2.2. Profit
`3.2.3. Entry
`3.2.4. Price
`3.2.5. Quality
`3.3. Summary
`4. Monopoly advertising
`4.1. The positive theory of monopoly advertising
`4.1.1. The Dorfman–Steiner model
`
`Handbook of Industrial Organization, Volume 3
`Edited by M. Armstrong and R. Porter
`© 2007 Elsevier B.V. All rights reserved
`DOI: 10.1016/S1573-448X(06)03028-7
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`4.1.2. Two examples
`4.2. The normative theory of monopoly advertising
`4.2.1. The persuasive view
`4.2.2. An alternative approach
`4.2.3. Price-maintaining and price-decreasing monopoly advertising
`4.2.4. Price-increasing monopoly advertising
`4.3. Summary
`5. Advertising and price
`5.1. Homogeneous products
`5.2. Differentiated products
`5.3. Non-price advertising
`5.4. Loss leaders
`5.5. Summary
`6. Advertising and quality
`6.1. Signaling-efficiency effect
`6.2. Repeat-business effect
`6.3. Match-products-to-buyers effect
`6.4. Quality-guarantee effect
`6.5. Summary
`7. Advertising and entry deterrence
`7.1. Advertising and goodwill
`7.2. Advertising and signaling
`7.3. Summary
`8. Empirical analyses
`8.1. Advertising and the household
`8.2. Advertising and firm conduct
`8.3. Summary
`9. Sunk costs and market structure
`9.1. Main ideas
`9.2. Econometric tests and industry histories
`9.3. Related work
`9.4. Summary
`10. New directions and other topics
`10.1. Advertising and media markets
`10.2. Advertising, behavioral economics and neuroeconomics
`10.3. Other topics
`10.4. Summary
`11. Conclusion
`Acknowledgements
`References
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`Ch. 28: The Economic Analysis of Advertising
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`Abstract
`
`This chapter offers a comprehensive survey of the economic analysis of advertising.
`A first objective is to organize the literature in a manner that clarifies what is known.
`A second objective is to clarify how this knowledge has been obtained. The chap-
`ter begins with a discussion of the key initial writings that are associated with the
`persuasive, informative and complementary views of advertising. Next, work that char-
`acterizes empirical regularities between advertising and other variables is considered.
`Much of this work is conducted at the inter-industry level but important industry stud-
`ies are also discussed. The chapter then offers several sections that summarize formal
`economic theories of advertising. In particular, respective sections are devoted to pos-
`itive and normative theories of monopoly advertising, theories of price and non-price
`advertising, theories of advertising and product quality, and theories that explore the
`potential role for advertising in deterring entry. At this point, the chapter considers the
`empirical support for the formal economic theories of advertising. A summary is pro-
`vided of empirical work that evaluates the predictions of recent theories of advertising,
`including work that specifies and estimates explicitly structural models of firm and con-
`sumer conduct. This work is characterized by the use of industry (or brand) and even
`household-level data. The chapter then considers work on endogenous and exogenous
`sunk cost industries. At a methodological level, this work is integrative in nature: it
`develops new theory that delivers a few robust predictions, and it then explores the em-
`pirical relevance of these predictions at both inter-industry and industry levels. Finally,
`the chapter considers new directions and other topics. Here, recent work on advertising
`and media markets is discussed, and research on behavioral economics and neuroeco-
`nomics is also featured. A final section offers some concluding thoughts.
`
`Keywords
`
`Advertising, Survey, Theory, Empirical analysis
`
`JEL classification: M300, L100, D800
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`“What makes the advertising issue fascinating . . . is that it is fundamentally an issue in how to establish
`truth in economics.” (Phillip Nelson, 1974a)
`
`1. Introduction
`
`By its very nature, advertising is a prominent feature of economic life. Advertising
`reaches consumers through their TV sets, radios, newspapers, magazines, mailboxes,
`computers and more. Not surprisingly, the associated advertising expenditures can be
`huge. For example, Advertising Age (2005) reports that, in 2003 in the U.S., General
`Motors spent $3.43 billion to advertise its cars and trucks; Procter and Gamble devoted
`$3.32 billion to the advertisement of its detergents and cosmetics; and Pfizer incurred a
`$2.84 billion advertising expense for its drugs. Advertising is big business indeed.
`From the current perspective, it is thus surprising to learn that the major economists
`of the 19th century and before paid little attention to advertising. The economic analy-
`sis of advertising is almost entirely a 20th-century project. Why did not 19th-century
`economists analyze advertising? Two reasons stand out.
`First, 19th-century economic research is devoted largely to the development of the
`theory of perfect competition, and this theory does not immediately suggest a role for
`advertising. As Pigou (1924, pp. 173–174) remarks, “Under simple competition there
`is no purpose in this advertisement, because, ex hypothesi, the market will take, at the
`market price, as much as any one small seller wants to sell”. Of course, whether a firm
`is competitive (i.e., price-taking) or not, it might advertise if it were thereby able to
`shift its demand curve upward so that a higher price could be obtained. But here a more
`basic problem arises: under the conventional assumptions that consumers have fixed
`preferences over products and perfect information with regard to prices and qualities,
`there is no reason for consumers to respond to advertising, and so the posited demand
`shift is unjustified.1
`Second, while advertising has long been used by merchants, its transition to “big
`business” is more modern. In the late 19th and early 20th centuries, following signif-
`icant advances in transportation (railroads) and communication (telegraph) networks,
`manufacturers were motivated to pursue innovations in the machinery of production
`and distribution, so that economies of scale could be reaped. These economies, how-
`ever, could be achieved only if demand were appropriately stimulated. The turn-of-
`the-century technological innovations that are associated with mass production and
`
`1 As Braithwaite (1928, p. 28) explains: “Under conditions of perfect competition producers would gain
`nothing by spending money on advertisement, for those conditions assume two things – (1) that the demand
`curve is fixed and cannot be altered directly by producers, and (2) that since producers can sell all that they
`can produce at the market price, none of them could produce (at a given moment) more at that price than they
`are already doing”.
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`Ch. 28: The Economic Analysis of Advertising
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`distribution thus gave significant encouragement to large-scale brand advertising and
`mass marketing activities.2
`At the beginning of the 20th century, advertising was thus a ripe topic for economic
`research. The economic analysis of advertising begins with Marshall (1890, 1919),
`who offers some insightful distinctions, and then gathers momentum with Chamber-
`lin’s (1933) integration of selling costs into economic theory. Over the second half of
`the century, the economic analysis of advertising has advanced at a furious pace. Now,
`following the close of the 20th century, a substantial literature has emerged. My purpose
`here is to survey this literature.
`In so doing, I hope to accomplish two objectives. A first objective is to organize the
`literature in a manner that clarifies what is known.3 Of course, it is impossible to sum-
`marize all of the economic studies of advertising. Following a century of work, though,
`this seems a good time to bring to the surface the more essential contributions and take
`inventory of what is known. Second, I hope to clarify how this knowledge has been
`obtained. The economic implications of advertising are of undeniable importance; how-
`ever, the true nature of these implications has yielded but slowly to economic analysis.
`There is a blessing in this. With every theoretical and empirical methodological inno-
`vation in industrial organization, economists have turned to important and unresolved
`issues in advertising, demonstrating the improvements that their new approach offers.
`Advertising therefore offers a resilient set of issues against which to chart the progress
`gained as industrial organization methods have evolved.
`It is helpful to begin with a basic question: Why do consumers respond to advertising?
`An economic theory of advertising can proceed only after this question is confronted.
`As economists have struggled with this question, three views have emerged, with each
`view in turn being associated with distinct positive and normative implications.
`The first view is that advertising is persuasive. This is the dominant view expressed
`in economic writings in the first half of the 20th century. The persuasive view holds that
`advertising alters consumers’ tastes and creates spurious product differentiation and
`brand loyalty. As a consequence, the demand for a firm’s product becomes more inelas-
`tic, and so advertising results in higher prices. In addition, advertising by established
`firms may give rise to a barrier to entry, which is naturally more severe when there are
`economies of scale in production and/or advertising. The persuasive approach therefore
`suggests that advertising can have important anti-competitive effects, as it has no “real”
`
`2 The emergence of large-scale advertising is also attributable to income growth, printing and literacy ad-
`vances, and urbanization. See also Borden (1942), Chandler (1990), Harris and Seldon (1962), Pope (1983),
`Simon (1970) and Wood (1958).
`3 Surprisingly, there does not appear to exist another contemporary and comprehensive survey of the eco-
`nomic analysis of advertising. Various portions of the literature are treated in other work. For example,
`Ekelund and Saurman (1988) offer an interesting discussion of early views on advertising by economists,
`and Comanor and Wilson (1979) and Schmalensee (1972) provide valuable surveys of early empirical analy-
`ses. Tirole (1988) discusses in detail a few of the recent theories of advertising. Finally, in Volumes 1 and 2
`of the Handbook of Industrial Organization, Schmalensee (1989) provides further discussion of empirical
`findings, while Stiglitz (1989) offers some brief reflections on the theory of advertising.
`
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`value to consumers, but rather induces artificial product differentiation and results in
`concentrated markets characterized by high prices and profits.
`The second view is that advertising is informative. This view emerged in force in
`the 1960s, under the leadership of the Chicago School. According to this approach,
`many markets are characterized by imperfect consumer information, since search costs
`may deter a consumer from learning of each product’s existence, price and quality. This
`imperfection can lead to market inefficiencies, but advertising is not the cause of the
`problem. Instead, advertising is the endogenous response that the market offers as a so-
`lution. When a firm advertises, consumers receive at low cost additional direct (prices,
`location) and/or indirect (the firm is willing to spend on advertising) information. The
`firm’s demand curve becomes more elastic, and advertising thus promotes competition
`among established firms. As well, advertising can facilitate entry, as it provides a means
`though which a new entrant can publicize its existence, prices and products. The sug-
`gestion here, then, is that advertising can have important pro-competitive effects.
`A third view is that advertising is complementary to the advertised product. Accord-
`ing to this perspective, advertising does not change consumers’ preferences, as in the
`persuasive view; furthermore, it may, but need not, provide information. Instead, it is
`assumed that consumers possess a stable set of preferences into which advertising en-
`ters directly in a fashion that is complementary with the consumption of the advertised
`product. For example, consumers may value “social prestige”, and the consumption of
`a product may generate greater prestige when the product is (appropriately) advertised.
`An important implication is that standard methods may be used to investigate whether
`advertising is supplied to a socially optimal degree, even if advertising conveys no in-
`formation.
`These views are all, at some level, plausible. But they have dramatically different pos-
`itive and normative implications. The persuasive and informative views, in particular,
`offer conflicting assessments of the social value of advertising. It is of special impor-
`tance, therefore, to subject these views to rigorous empirical and theoretical evaluation.
`Over the past fifty years, the economic analysis of advertising, like the field of industrial
`organization itself, can be described in terms of a sequence of empirical, theoretical and
`again empirical evaluative phases.
`The empirical analysis of advertising was at center stage from the 1950s through the
`1970s. Over this period, a voluminous literature investigated general empirical relation-
`ships between advertising and a host of other variables, including concentration, profit,
`entry and price. Much of this work employs regression methods and uses inter-industry
`data, but important studies are also conducted at the industry, firm and even brand levels.
`This period is marked by vigorous and mostly edifying debates between advocates of
`the persuasive and informative views. The debates center on both the robustness and the
`interpretation of empirical findings, and they identify some of the limitations of regres-
`sion analyses, particularly at the inter-industry level. While the inter-industry analyses
`are often inconclusive, defensible empirical patterns emerge within particular industries
`or narrow industry categories. The evidence strongly suggests that no single view of
`advertising is valid in all settings.
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`Ch. 28: The Economic Analysis of Advertising
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`The empirical studies suggest important roles for advertising theory. First, theoreti-
`cal work might make progress where empirical work has failed. A general theoretical
`argument might exist, for example, that indicates that advertising is always excessively
`supplied by the market. Likewise, a theoretical model might assess the validity of the
`persuasive-view hypothesis that advertising deters entry. Second, advances in the theory
`of advertising might generate new predictions as to the relationships between advertis-
`ing and market structure. In turn, these predictions could motivate new empirical work.
`Third, and relatedly, theoretical work might provide a foundation from which to appro-
`priately specify the supply side of more sophisticated econometric analyses, in which
`the endogeneity of consumer and firm conduct is embraced. Utilizing recent advances
`in game theory, economists thus began in the late 1970s to advance formal theories of
`advertising. This work is vital and ongoing.
`Beginning in the 1980s, economists approached the empirical analyses of advertising
`with renewed interest. For the purposes of this survey, it is useful to organize the modern
`work in three broad groups. Studies in the first group often use new data sources and
`further evaluate the empirical findings of the earlier empirical work. These studies are
`not strongly influenced by the intervening theoretical work. Studies in the second group
`also draw on new data sets, sometimes constructed at the brand and even household
`levels, and reflect more strongly the influence of the intervening theoretical work. The
`conduct of firms and consumers in particular industries is emphasized. Studies in this
`group evaluate the predictions of strategic theories of advertising, and may even specify
`and estimate explicit structural models of consumer and firm conduct. Finally, following
`Sutton (1991), a third group of studies culls from the intervening theoretical work a few
`robust predictions that might apply across broad groups of industries. Studies in the
`third group thus sometimes return to the inter-industry focus that characterized much of
`the earlier empirical work; however, the empirical analysis is now strongly guided by
`general theoretical considerations.
`This historical description provides a context in which to understand the organiza-
`tion of this survey. In Section 2, I describe the work of Marshall (1890, 1919) and
`Chamberlin (1933), and I review the key initial writings that are associated with each
`of the three views. This discussion is developed at some length, since these writings
`contain the central ideas that shape (and are often re-discovered by) the later literature.
`Section 3 contains a summary of the findings of the initial and modern (first-group)
`empirical efforts.4 In Sections 4 through 7, I present research on advertising theory.
`Next, in Section 8, I describe the modern (second-group) empirical efforts. The modern
`(third-group) work is discussed in Section 9. Section 10 identifies new directions and
`omitted topics, and Section 11 concludes.
`The survey is comprehensive and thus long. The sections are organized around topics,
`however, making it easy to locate the material of greatest interest. For teaching purposes,
`
`4 It is not always clear whether a study belongs in the first or second group. When there is any ambiguity,
`I place the study in the first group, so that the topic treatments found in Section 3 may be more self contained.
`
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`if a thorough treatment of advertising is planned, then the survey may be assigned in
`full. Alternatively, if the plan is to focus on a particular topic within advertising, then
`Section 2 and the section that covers the corresponding topic may be assigned. Section 2
`provides a general context in which to understand any of the topic treatments found in
`later sections.
`
`2. Views on advertising
`
`In this section, I discuss the key initial writings that led to each of the three main views
`(persuasive, informative, complementary) of advertising. The assignment of economists
`to views is, to some degree, arbitrary, as it is commonly recognized that advertising
`can influence consumer behavior for different reasons. There are, however, important
`differences in emphasis among many of the key contributors. I begin with Marshall
`(1890, 1919) and especially Chamberlin (1933), who set the stage by identifying some
`of the possible views and implications of advertising. I then review the key contributions
`that emphasize more forcefully the development of one view over another. The section
`concludes with a general discussion that inventories the potential social benefits and
`costs of advertising.
`
`2.1. Setting the stage
`
`Some initial reflections on advertising are offered by Marshall (1890, 1919). As
`Marshall (1919) explains, advertising can play a constructive role by conveying in-
`formation to consumers. Constructive advertising can alert consumers to the existence
`and location of products, and it can also convey (pre-purchase) information concerning
`the functions and qualities of products. But Marshall (1890, 1919) also emphasizes that
`some kinds of advertising can be socially wasteful. In particular, some advertising in-
`volves repetitive messages, and such advertising plays a combative role, as its apparent
`purpose is to redistribute buyers from a rival firm to the advertising firm.5
`Unfortunately, Marshall did not pursue a formal integration of advertising into eco-
`nomic theory. With the development of his theory of monopolistic competition, how-
`ever, Chamberlin (1933) embraces this integration. Fundamental to Chamberlin’s ap-
`proach is the assumption that, within a given industry, firms sell differentiated products.
`
`5 Along with Marshall (1890, 1919), other early contributors to the economic analysis of advertising include
`Fogg-Meade (1901), Pigou (1924), Shaw (1912), Sherman (1900) and Shryer (1912). Fogg-Meade argues that
`advertising is a positive force for society, since it educates consumers by bringing new goods to their attention.
`Pigou emphasizes that much advertising is combative and thus socially wasteful. Shaw argues that advertising
`enables manufacturers to by-pass the middleman and establish their brand names with consumers. Advertising
`thus gives manufacturers incentive to maintain reputations for high quality. Sherman details the extent and
`nature of advertising in the U.S. in the 19th century. He also observes that advertising can play constructive
`and combative roles. Shryer offers one of the first quantitative studies of advertising. Using mail-order data,
`he argues that the effect of advertising on sales exhibits decreasing returns.
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`Ch. 28: The Economic Analysis of Advertising
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`As a consequence, each firm faces a downward-sloping demand curve and thus pos-
`sesses some monopoly power. Chamberlin argues additionally that a firm can use adver-
`tising and other promotional activities to further differentiate its product from those of
`its rivals. Advertising-induced product differentiation is beneficial to a firm as a means
`of expanding its market; in graphical terms, by advertising, a firm generates an outward
`shift in its demand curve. When a firm considers increasing its advertising, it thus bal-
`ances this market-expansion benefit against the additional “selling costs” that such an
`increase would entail.
`Chamberlin does not model consumer behavior explicitly, and he takes as given that
`consumers respond to advertising. He does, however, offer two explanations for the pre-
`sumed responsiveness. Chamberlin (1933, pp. 118–120) argues that advertising affects
`demand, because it (i) conveys information to consumers, with regard to the existence
`of sellers and the price and qualities of products in the marketplace, and (ii) alters con-
`sumers’ “wants” or tastes. When advertising communicates information that concerns
`the existence of the firm’s product, the effect is to expand the firm’s market with an out-
`ward shift in demand. If advertising conveys price information as well, then the firm’s
`expanded demand curve also may be more elastic, as more consumers then can be in-
`formed of a price reduction. But if advertising serves its second general purpose – that
`of creating wants through brand development and the like – then the advertising firm’s
`demand curve shifts out and may be made more inelastic. Chamberlin thus identifies
`the informative and persuasive roles for advertising.
`Scale economies figure prominently in Chamberlin’s approach. First, Chamberlin as-
`sumes that a firm’s production technology is characterized by increasing returns to scale
`up to a critical level of output. Second, Chamberlin (1933, pp. 133–136) stresses as well
`that there may be an economy of scale in advertising. To motivate this scale economy,
`Chamberlin argues that (i) a consumer’s responsiveness to advertising messages may
`be “fortified by repetition”, and (ii) there may be improvement in the organization of
`advertising expenditures at higher levels, as gains from specialization in selling are real-
`ized and as more effective media (which may be accessible only at higher expenditures)
`are used. At the same time, beyond a critical sales volume, diminishing returns are in-
`evitable, since additional advertising becomes less effective once the most responsive
`buyers are already reached. In total, Chamberlin concludes that the unit costs of produc-
`tion and selling are each U-shaped, and on this basis he argues that a firm’s combined
`unit cost curve is U-shaped as well.
`Using these ingredients, Chamberlin describes a monopolistic–competition equilib-
`rium, in which each firm sets its monopoly price and yet earns zero profit. As the
`standard textbook diagram depicts, at the firm’s monopoly price, its downward-sloping
`demand curve is just tangent to its combined unit cost curve. Chamberlin argues that
`this tangency is a necessary consequence of the competitive forces of entry. In this
`general manner, Chamberlin reconciles monopolistic and competitive forces, by intro-
`ducing a modeling paradigm that emphasizes product differentiation, scale economies
`and advertising.
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`In an important application of his framework, Chamberlin (1933, pp. 165–167)
`considers the possible price effects of advertising. He compares the monopolistic-
`competition equilibrium when advertising is allowed with the corresponding equilib-
`rium that would emerge if advertising were not allowed. On the one hand, the demand-
`expanding effect of advertising enables firms to better achieve economies of scale in
`production, and this scale effect works to reduce prices.6 On the other hand, advertis-
`ing entails selling costs, and so a firm’s combined unit cost is higher when advertising
`is permitted. In a zero-profit equilibrium, this cost effect works to increase prices. Fi-
`nally, advertising affects pricing as well through an elasticity effect. When advertising
`increases the elasticity of a firm’s demand, as advertising might when it contains price
`information, there is further support for the suggestion that advertising reduce prices.
`Of course, the opposite suggestion is given further credence, if advertising makes the
`firm’s demand less elastic, as advertising might when it creates wants and encourages
`brand loyalty.
`In light of these conflicting effects, Chamberlin (1933, p. 167) concludes that the net
`effect of advertising on prices cannot be resolved by theory alone: “The effect of ad-
`vertising in any particular case depends upon the facts of the case.” Among these facts,
`Chamberlin’s discussion clearly suggests that the purpose of advertising (persuasive or
`informative) and the extent of scale economies (in production and advertising) warrant
`greatest attention. This is a balanced and penetrating suggestion. It also serves to pro-
`vide a general context in which to understand subsequent research, wherein economists
`debate the purpose of advertising and the probable extent of scale economies.
`
`2.2. The persuasive view
`
`In the writings that initially followed Chamberlin’s effort, advertising’s persuasive pow-
`ers are given primary emphasis. These writings acknowledge a role for scale economies,
`under which advertising may exert a price-reducing influence, but the conclusion that
`emerges is that advertising may have important anti-competitive consequences. In ar-
`riving at this conclusion, the persuasive-view advocates go beyond Chamberlin to em-
`phasize that advertising has an entry-deterrence effect: when advertising creates brand
`loyalty, it also creates a barrier to entry, since established firms are then able to charge
`high prices and earn significant profits without facing entry. As I describe below, the
`persuasive view is developed through an increasingly sophisticated set of conceptual
`and empirical arguments.
`In fact, the first advocates of the persuasive view were contemporaries of Chamber-
`lin’s. In her development of the theory of imperfect competition, Robinson (1933, p. 5)
`includes some brief discussion of advertising, in which she argues that “the customer
`will be influenced by advertisement, which plays upon his mind with studied skill, and
`
`6 Marshall (1890, ch. XIV) also briefly discusses the possibility that advertising induces a beneficial scale
`effect.
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`Ch. 28: The Economic Analysis of Advertising
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`makes him prefer the goods of one producer to those of another because they are brought
`to his notice in a more pleasing and forceful manner”. Likewise, in considering the po-
`tential anti-competitive implications of advertising, Robinson (1933, p. 101) claims that
`if “a firm finds the market becoming uncomfortably perfect (i.e., more competitive)
`it can resort to advertisement and other devices which attach customers more firmly
`to itself”. In total, Robinson suggests that advertising has strong anti-competitive con-
`sequences, since it deters entry and sustains monopoly power in a market where the
`conduct of established firms otherwise would be suitably disciplined by competitive
`pressures.
`In a perceptive paper that, unaccountably, now seems largely forgotten, Braithwaite
`(1928) contributes significantly toward a conceptual foundation for the persuasive
`view.7 Braithwaite regards advertising as a “selling cost”, the purpose of which is to
`re-arrange consumers’ valuations, so that they are persuaded to value more greatly
`the advertised product. Advertising shifts out a consumer’s demand for the advertised
`product, and it thus distorts the consumer’s decisions as compared to those that reflect
`his “true” preferences (as captured in his pre-advertising demand). The real economic
`resources that are expended through advertising activities thus may be wasted, since ad-
`vertising’s effect is to induce consumers to purchase the wrong quantities of goods that
`are not well adapted to their true needs at prices that are swollen from the cost effect of
`advertising. On the other hand, Braithwaite recognizes that advertising may also induce
`a scale effect that exerts a downward pressure on price.
`In light of these competing influences, Braithwaite (1928, p. 35) establishes the fol-
`lowing result: if a monopolist’s advertising shifts out the demand for its product, and
`if consumer surplus is evaluated relative to the initial (pre-advertising) demand, then
`advertising increases consumer surplus only if it is accompanied by a strict reduction
`in price. Figure 28.1 illustrates that consumer surplus may fall, even if there is a strict
`reduction in price. The consumer surplus gain from a lower price is marked as G, while
`the consumer surplus loss that comes from distorted consumption is marked as L. Cer-
`tainly, L can exceed G if the price decrease is modest, and L necessarily exceeds G if
`price is unaltered.
`Braithwaite also advances the entry-deterrence effect of advertising. She argues that,
`by advertising, an established firm creates a “reputation” for its brand among con-
`sumers. New entrants can then succeed only by developing their own reputation through
`advertising, and Braithwaite (1928, p. 32) claims that for them the necessary expendi-
`tures may be even higher: “But, since they have to create reputation in the face of one
`already established, the probability is that their advertisement costs will be heavier than
`those of the original manufacturer”. Advertising thus may result in the creation of “rep-
`utational monopolies”. This entry-deterrence effect offers further support for the belief
`that advertising causes higher prices and lower welfare.
`
`7 Braithwaite (1928) and Chamberlin (1933) cover some similar terrain, and the contributions appear to be
`independent [see Chamberlin (1933, p. 126)].
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`PAGE 11 OF 144
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`1712
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`K. Bagwell
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`Figure 28.1. Consumption distortion.
`
`Finally, Braithwaite (1928, p. 36) considers whether reputation itself may confer
`some possible benefit to the consumer. She states one possibility: “Advertisers main-
`tain that their reputation is a guarantee of quality. For they say that it is not worth a
`manufacturer’s while to stake his name and spend his money on advertising an article
`of poor quality.” In the end, she argues that the quality-guarantee effect is modest.8
`Her reasons are that: (i) factually, reputations are sometimes created for inferior goods
`which enjoy short-lived profits, (ii) consumers can be poor judges of quality, and they
`may linger with an inferior product, and (iii) any such guarantee is to some degree re-
`dundant, since a reliable retailer already offers an implicit guarantee as to the quality
`of prod