Economic Defence of Advertising

Honoré Daumier: Outside the Print–Seller's Shop // Public domain

Advertisements are generally regarded as a socially undesirable phenomenon. At best, they are seen as a poor source of information about a company’s products in an attempt to raise awareness of their existence and thereby win new customers, but more often as a despicable practice aimed at manipulating consumer preferences.

The fact that this phenomenon is incompatible with the model of perfect competition has led many economists to consider it negative or even to label it outright as a form of market failure. In this article, I will be a bit of an advocatus diaboli, since I will take the liberty of using economic theory to defend advertising as a useful element of the market economy.

Let’s start first with the simple question of why companies are willing to devote a significant portion of their revenues to the costs associated with advertising their goods or services in the first place. The answer is not unexpected – it is a profit-maximizing strategy for the producer in the given circumstances. The willingness to exchange financial resources for the opportunity to advertise is higher the more differentiated (the more specific and the more different they are from competitive substitutes) the goods that firms try to entice consumers to buy.

As Israel Kirzner writes, in order to satisfy the wishes of consumers and to profit from this win-win trade, it is not enough for producers to produce the goods they believe consumers would most prefer. As far as possible they must also make available the relevant information which may influence consumers in their choice between more or less similar substitutes or which may create a completely new image of the need to satisfy one of their desires, the presence of which they would not have been aware of had they not seen the particular product which has created this feeling of urgency in their minds (‘activated their demand’).

However, the mere availability of this information may still not be enough, because by its nature it does not guarantee that it will actually reach those for whom it would be useful and for whom it could be of considerable help in their decision-making, at the right time.

Producers are thus to some extent obliged to use the tools of advertising not only to provide consumers with valuable information to convince them that their product is so special, but also to alert potential customers to the existence of the product or its quality. It is therefore not only a means of highlighting the differences between the goods sold compared with other goods of a similar kind, but also a source of information which, if discovered, will lead consumers to purchase the goods in question, which would never have happened if a similar impulse had not been initiated.

Of course, it can be argued that every coin has two sides and that one of them is particularly shady in advertising. It is characteristic of advertisements that they have a psychological role in addition to their informative nature. Specifically, this involves a tried-and-tested strategy of associating, through advertising, a particular product with (mostly positive) emotions that will subconsciously influence the consumer’s choice because he will then, without being aware of it, consider them to be part of the product he is considering buying.

Isn’t such psychological pressure exerted on the consumer by advertising contemptible, even if it is slight? Not necessarily, for as Gary Becker, the 1992 Nobel Prize winner in economics, describes, consumers respond to similar social and psychological pressures when they consider dining in prestigious restaurants, owning luxury cars, and many other goods.

Finally, let us mention one more positive role that advertising can play in one of the widely mentioned areas of market failure, namely public goods, which the free market is said to be unable to provide to an appropriate degree because of the seemingly intractable problem of the stowaway. For example, television or radio broadcasting are purely public goods (consumers cannot be excluded from consuming a good that is also non-rivalrous, i.e. the individual does not prevent or restrict the consumption of others). In theory, this would imply that such services (for which the marginal utility of consumers should significantly exceed the marginal cost of producers) will not be available on the markets.

However, the reality is different. These services are provided solely by private entities, which bind this purely public good in an unbreakable bond with the purely private good of being able to advertise the products of firms (advertising), thereby very skillfully overcoming those theoretically insurmountable obstacles to the private provision of public goods.

Written by Štěpán Drábek – analyst at CETA.

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