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`Columbia University
`Department of Economics
`Discussion Paper Series
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`The Economic Analysis of Advertising
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`Kyle Bagwell
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`Discussion Paper No.: 0506-01
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`Department of Economics
`Columbia University
`New York, NY 10027
`August 2005
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`Biogen Exhibit 2196
`Mylan v. Biogen
`IPR 2018-01403
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`The Economic Analysis of Advertising
`by Kyle Bagwell
`This version: August 2005
`
`1. Introduction (pages 1-6)
`
`2. Views on Advertising (pages 6-25)
`2.1. Setting the Stage
`2.2. The Persuasive View
`2.3. The Informative View
`2.4. The Complementary View
`2.5. Summary
`
`3. Empirical Regularities (pages 25-54)
`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
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`4. Monopoly Advertising (pages 54-69)
`4.1. The Positive Theory of Monopoly Advertising
`4.1.1. The Dorfman-Steiner Model
`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
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`5. Advertising and Price (pages 69-83)
`5.1. Homogenous Products
`5.2. Differentiated Products
`5.3. Non-Price Advertising
`5.4. Loss Leaders
`5.5. Summary
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`6. Advertising and Quality (pages 84-104)
`6.1. Signaling-Efficiency Effect
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`1
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`6.2. Repeat-Business Effect
`6.3. Match-Products-to-Buyers Effect
`6.4. Quality-Guarantee Effect
`6.5. Summary
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`7. Advertising and Entry Deterrence (pages 104-118)
`7.1. Advertising and Goodwill
`7.2. Advertising and Signaling
`7.3. Summary
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`8. Empirical Analyses (pages 118-130)
`8.1. Advertising and the Household
`8.2. Advertising and Firm Conduct
`8.3. Summary
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`9. Sunk Costs and Market Structure (pages 130-139)
`9.1. Main Ideas
`9.2. Econometric Tests and Industry Histories
`9.3. Related Work
`9.4. Summary
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`10. New Directions and Other Topics (pages 139-147)
`10.1 Advertising and Media Markets
`10.2 Advertising, Behavioral Economics and Neuroeconomics
`10.3 Other Topics
`10.4 Summary
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`11. Conclusion (page 147)
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`12. References (pages 148-176)
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`Figures 1-3b
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`2
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`The Economic Analysis of Advertising
`
`Kyle Bagwell∗
`
`This version: August 2005
`
`“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. Adver-
`tising reaches consumers through their TV sets, radios, newspapers, magazines,
`mailboxes, computers and more. Not surprisingly, the associated advertising ex-
`penditures 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 dollar 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 analysis of advertising is almost entirely a 20th-century project. Why
`didn’t 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
`
`∗Columbia University (Kelvin J. Lancaster Professor of Economic Theory in the Department
`of Economics, and Professor of Finance and Economics in the Graduate School of Business).
`I thank Susan Athey, Alberto Martin, Martin Peitz, Per Baltzer Overgaard, Michael Riordan,
`Victor Tremblay, Ting Wu and especially Mark Armstrong and Rob Porter for helpful comments.
`Discussions with Andrew Pyo and Laura Silverman are also gratefully acknowledged.
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`role for advertising. As Pigou (1924, pp. 173-4) remarks, “Under simple competi-
`tion 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 in-
`formation 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
`significant advances in transportation (railroads) and communication (telegraph)
`networks, manufacturers were motivated to pursue innovations in the machin-
`ery of production and distribution, so that economies of scale could be reaped.
`These economies, however, could be achieved only if demand were appropriately
`stimulated. The turn-of-the-century technological innovations that are associated
`with mass production and 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 Chamberlin’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
`
`1As 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.”
`2The emergence of large-scale advertising is also attributable to income growth, printing
`and literacy advances, and urbanization. See also Borden (1942), Chandler (1990), Harris and
`Seldon (1962), Pope (1983), Simon (1970) and Wood (1958).
`3Surprisingly, there does not appear to exist another contemporary and comprehensive survey
`of the economic analysis of advertising. Various portions on the literature are treated in other
`work. For example, Ekelund and Saurman (1988) offer an interesting discussion of early views
`
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`to summarize 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; however, 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 innovation 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 ques-
`tion 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 inelastic, 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” 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 ap-
`proach, 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
`
`on advertising by economists, and Comanor and Wilson (1979) and Schmalensee (1972) provide
`valuable surveys of early empirical analyses. 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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`is not the cause of the problem. Instead, advertising is the endogenous response
`that the market offers as a solution. 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 suggestion here,
`then, is that advertising can have important pro-competitive effects.
`A third view is that advertising is complementary to the advertised product.
`According 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 enters directly in a fashion that is complementary with the con-
`sumption 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 stan-
`dard methods may be used to investigate whether advertising is supplied to a
`socially optimal degree, even if advertising conveys no information.
`These views are all, at some level, plausible. But they have dramatically
`different positive and normative implications. The persuasive and informative
`views, in particular, offer conflicting assessments of the social value of advertising.
`It is of special importance, 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 relationships between advertising and a host of other variables, includ-
`ing 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 em-
`pirical findings, and they identify some of the limitations of regression analyses,
`particularly at the inter-industry level. While the inter-industry analyses are of-
`ten inconclusive, defensible empirical patterns emerge within particular industries
`or narrow industry categories. The evidence strongly suggests that no single view
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`of advertising is valid in all settings.
`The empirical studies suggest important roles for advertising theory. First,
`theoretical 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 en-
`try. Second, advances in the theory of advertising might generate new predictions
`as to the relationships between advertising and market structure. In turn, these
`predictions could motivate new empirical work. Third, and relatedly, theoretical
`work might provide a foundation from which to appropriately specify the supply
`side of more sophisticated econometric analyses, in which the endogeneity of con-
`sumer 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 ad-
`vertising 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 the-
`oretical 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 con-
`sumers 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 character-
`ized much of the earlier empirical work; however, the empirical analysis is now
`strongly guided by general theoretical considerations.
`This historical description provides a context from which to understand the or-
`ganization 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 ini-
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`tial 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, if a thorough treatment of advertising is planned, then the sur-
`vey 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 corre-
`sponding 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
`information to consumers. Constructive advertising can alert consumers to the
`existence and location of products, and it can also convey (pre-purchase) infor-
`mation 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 involves repetitive messages, and such advertising
`
`4It 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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`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 economic theory. With the development of his theory of monopolistic com-
`petition, however, Chamberlin (1933) embraces this integration. Fundamental to
`Chamberlin’s approach is the assumption that, within a given industry, firms sell
`differentiated products. As a consequence, each firm faces a downward-sloping
`demand curve and thus possesses some monopoly power. Chamberlin argues
`additionally that a firm can use advertising and other promotional activities to
`further differentiate its product from those of its rivals. Advertising-induced prod-
`uct 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 balances this
`market-expansion benefit against the additional “selling costs” that such an in-
`crease 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 presumed 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 consumers’ “wants” or tastes. When advertising com-
`municates information that concerns the existence of the firm’s product, the effect
`is to expand the firm’s market with an outward 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 informed of a price reduc-
`tion. But if advertising serves its second general purpose - that of creating wants
`through brand development and the like - then the advertising firm’s demand
`
`5Along 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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`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, Cham-
`berlin assumes that a firm’s production technology is characterized by increasing
`returns to scale up to a critical level of output. Second, Chamberlin (1933, pp.
`133-36) 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 responsive-
`ness 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 realized 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 inevitable, since ad-
`ditional advertising becomes less effective once the most responsive buyers are
`already reached. In total, Chamberlin concludes that the unit costs of production
`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 equi-
`librium, 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. Cham-
`berlin 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 introducing a modeling paradigm that emphasizes product
`differentiation, scale economies and advertising.
`In an important application of his framework, Chamberlin (1933, pp. 165-7)
`considers the possible price effects of advertising. He compares the monopolistic-
`competition equilibrium when advertising is allowed with the corresponding equi-
`librium 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, advertising 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. Finally, 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 sugges-
`
`6Marshall (1890, Chapter XIV) also briefly discusses the possibility that advertising induces
`a beneficial scale effect.
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`tion 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 advertising 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 provide a general context in which to
`understand subsequent research, wherein economists debate the purpose of ad-
`vertising and the probable extent of scale economies.
`
`2.2. The Persuasive View
`
`In the writings that initially followed Chamberlin’s effort, advertising’s persuasive
`powers 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 arriving at this conclusion, the persuasive-view advocates go
`beyond Chamberlin to emphasize 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 prof-
`its 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
`Chamberlin’s. In her development of the theory of imperfect competition, Robin-
`son (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 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 potential anti-competitive implications of
`advertising, Robinson (1933, p.101) claims that if “a firm finds the market becom-
`ing uncomfortably perfect (i.e., more competitive) it can resort to advertisement
`and other devices which attach customers more firmly to itself.” In total, Robin-
`son suggests that advertising has strong anti-competitive consequences, since it
`deters entry and sustains monopoly power in a market where the conduct of es-
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`tablished firms otherwise would be suitably disciplined by competitive pressures.
`In a perceptive paper that, unaccountably, now seems largely forgotten, Braith-
`waite (1928) contributes significantly toward a conceptual foundation for the per-
`suasive 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 advertising’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
`following result: if a monopolist’s advertising shifts out the demand for its prod-
`uct, 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 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. Certainly, 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 ar-
`gues that, by advertising, an established firm creates a “reputation” for its brand
`among consumers. New entrants can then succeed only by developing their own
`reputation through advertising, and Braithwaite (1928, p. 32) claims that for
`them the necessary expenditures 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 “reputational monopolies.” This
`entry-deterrence effect offers further support for the belief that advertising causes
`higher prices and lower welfare.
`Finally, Braithwaite (1928, p. 36) considers whether reputation itself may con-
`fer some possible benefit to the consumer. She states one possibility: “Advertisers
`
`7Braithwaite (1928) and Chamberlin (1933) cover some similar terrain, and the contributions
`appear to be independent (see Chamberlin (1933, p. 126)).
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`maintain 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 advertis-
`ing an article of poor quality.” In the end, she argues that the quality-guarentee
`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 redundant, since a reliable retailer already
`offers an implicit guarantee as to the quality of products sold in his store.
`In
`view of these considerations, Braithwaite (1928, p. 37) concludes that reputation
`does not offer advantages to consumers that are sufficient to compensate for the
`harmful effects of advertisement that she otherwise identifies.
`The persuasive view of advertising is further advanced by Kaldor (1950). He
`draws a distinction between the direct and indirect effects of advertising on social
`welfare. The direct effect of advertising is associated with its role in the provision
`of price and product-quality information to consumers, while the indirect effects of
`advertising include any consequent scale economies in production and distribution.
`Kaldor begins with the direct effect. Observing that the “price” of adver-
`tising to the buyer is typically zero, Kaldor regards advertising as a subsidized
`commodity (i.e., a commodity sold below marginal cost) that is sold jointly with
`the advertised product. Advertising is then profitable to the seller, because it
`is “complementary” to the advertised product (i.e., advertising increases the de-
`mand for the advertised product). As Kaldor explains, given the absence of a
`separate market for advertising and the associated divergence between price and
`marginal cost, there can be no presumption that the amount of advertising is
`efficient. Moreover, while advertising can convey information, this information is
`offered by an interested party. Kaldor (1950, p. 7) thus argues that the major-
`ity of advertising is persuasive in nature. After considering the direct effect of
`advertising, Kaldor suggests that advertising is a wasteful means of conveying a
`modest degree of information.
`If advertising is to be justified, then the justification must come from its in-
`direct effects. Here, the core of Kaldor’s argument is that advertising promotes
`greater concentration; hence, the primary indirect effects of advertising are the
`same as those that are associated with increased concentration. The indirect ef-
`fects thus can cut both ways. On the one hand, there may be a detrimental
`
`8Fogg-Meade (1901), Marshall (1919) and Shaw (1912) are early proponents of the quality-
`guarantee effect. In contrast to Braithwaite (1928), t