Economics Of Advertising

Advertising is a hugely influential part of society and business yet it is never mentioned in traditional economics. In neo-classical economics, firms do not advertise. This is not a trivial omission because advertising has an enormous effect on the market. Roughly $500 billion dollars was spent on advertising in 2011. Nor is its omission a simple mistake. Rather it is deliberate because once you examine advertising, you see what an enormous distorter of the market it is.

In any textbook example of perfect competition, all goods are homogenous (i.e. the same) and all consumers have perfect information. In this world there is no need for advertising because consumers know everything there is to know about the market. Likewise rational actors would not be swayed by marketing ploys or information irrelevant to the product (why would a beautiful model make a rational consumer more likely to buy the good?). It is for this reason that textbooks don’t mention advertising, to do so would to be to admit that consumers are irrational and that the market could be distorted.

Let’s examine the logic of advertising. The goal of advertising is to increase sales of the product either by convincing people who wouldn’t have otherwise bought the product to buy it, or by convincing existing consumers to buy more. This seems very obvious, but it goes against most of what economics students learn. Most economics lecturers explain that consumers choose what to buy based on their preferences and tastes. It is therefore wrong for the government to intervene because consumers alone know what’s best for themselves. However, if preferences can be manipulated or changed, then the standard theory of consumer choice goes out the window.

Take the standard economics notes and imagine a consumer is choosing how much pizza and chips to buy (I don’t know why but the examples are usually pizza and chips or some kind of fast food). A consumer makes a rational choice taking all the benefits and costs of either option before deciding to get, say, 5 slices of pizza and 2 portions of chips (like all examples in lectures, it is ridiculous simplified with only one consumer, two goods and no money). The lecture usually ends with a tribute to the sovereignty of the consumer in the free market, who simply by exercising choice, they end up in the optimal position that most improves their life. Let’s say now the chip company takes out an ad that boosts sales, so now the ratio is 4 pizza and 3 chips. What has happened? Has the market been distorted? Has the sovereignty of consumers’ preferences been violated?

This is why advertising is not discussed. It ruins the aura and glory of the free market and raises the possibility that leaving consumers to decide themselves isn’t as perfect as it first sounds. If a firm advertises, then it incurs a cost, therefore it will have to raise its price. Therefore a marketplace with advertising firms is less efficient. This is especially true in cases where advertising resembles an arms race where large amounts are spent with little gain. Goods are no longer sold at the lowest possible price and worst still choice is not made on the basis of quality but on irrational and irrelevant grounds.

A crucial point about advertising is that it is not commercial, but emotional. By this I mean ads do not try to convince you that a certain product is cheaper or more efficient, rather they aim to make the product seem enjoyable. A typical ad will show young, handsome, stylish people using the product and having fun. The implication is that if you use this product (even if it is not the cheapest or best quality) then you too will be popular and happy. Ads mainly try to make an emotional rather than logical connection with consumers and it is rare to even see the product in an ad. (After writing this, I stopped and watch some TV and therefore ads. The only ads that directly mention prices or compared products were the financial industry, probably the most rigid industry where few consumers switch supplier). Humour is another common method, the aim being to create positive connotations with the product.

Other common methods include celebrity endorsements which also create connotations between popular people and the product. Or just peer pressure where an ad shows large groups of people. Humans by our nature are social animals and we instinctively follow a group. This is natural as we trust other people and have an urge to associate with them. This is why the key to a successful consumer product is not low prices or a good quality, but popularity. If many people buy a product, this is one of the largest influences on getting other people to buy it. (Of course price and quality can influence whether or not a product is popular but it is rarely the largest influence). The world of sales is dominated by fads and fashions where some goods become “hot” or popular and everyone wants to buy them. The largest determinant of whether someone will commit an act ranging from smoking, to stealing, to buying a car to getting pregnant, is whether or not other people they know do so as well.

All of this is to say nothing of the hint of sex in advertising . . .

Advertising need not be an entirely negative influence. After all, it can provide consumers with information about how one product is better or cheaper than others. However, all businesses will try to show that their product is the best even if it isn’t. This is why if you turn on your television, you will not see any ads that compare their product with their rivals. Instead they barely even mention the product at all, engaging instead with shots that are irrelevant to the product (beautiful models, people laughing, scenes of home etc). If we were rational these would have no effect, but we are irrational so they do (otherwise why would companies spend so much money on them?).

This leads us onto the effect of brands. Many consumers have a connection and loyalty to a brand that no orthodox economist can explain. Consumers should shop around for the best deal and not make purchases for any other reason. However marketers have long known that this is not the case. Once people make a decision to but a certain product, they usually stick with it. People build a connection with a brand that is in some regards irrational. Even if a cheaper or better product is available, people will stick with “their” brand in the same way a fan will stick by their team even when its losing. Psychologists have found that a large amount of what we call attraction in fact comes from familiarity. Advertising makes a product more familiar and therefore more attractive (I have witnessed this first hand and have found myself strangely drawn towards brands I recognised from TV even if they weren’t the cheapest). In fact (as detailed in No Logo) major corporations like Nike and Coca-Cola are moving away from actually producing products and focusing instead on advertising and branding.

What would a world without advertising look like? Well, products would be cheaper as money currently spent on advertising would go into reducing the price or improving product quality. With advertising influencing demand, consumers would make better choices based on actual differences rather than on emotional impulses. Consumerism would suffer and people would buy less. People would not look for joy and fulfilment in material goods. The market would be more efficient and be a greater benefit to consumers. That is why advertising is one of the greatest distorters of the market.


Filed under Economics

13 responses to “Economics Of Advertising

  1. Eventually one comes to the point that there is no such thing as a free market, it being an idealized state useful only in textbook discussions, kind of like the frictionless surfaces physicist use in discussions as a way of isolating variables.

    Should not the professors of economics be throwing these monkey wrenches into their finely oiled academic machines? They leave the doubting to the students?

    Again, well done young man!

  2. Be interesting to superimpose this over the notion of Free Will.

  3. History of Capitalism

    Great post! Advertising has always seemed extremely suspect in a number of regards, not just in that it is often pretty ghastly stuff, but that it always seems torn between not making sense as such a huge industry and seeming like all that money spent on ads can’t possibly be effective enough to warrant that spending, and also they are how so many other industries (newspapers, television) are supposed to make a significant chunk of their money. From an entirely different perspective, they often appear to be social engineering, and thus present even more problems for the models and theories of supply and demand assumed by many economists. Anyway, keep fighting the good fight!

  4. Wouter

    Interesting post, but don’t agree with “advertising is not discussed”. What about Becker and Stigler? You may not agree with them, but at least advertising is discussed.

    • Actually I haven’t come across their discussion of advertising. I’m aware of Stigler’s influence on imperfect information and Becker’s theory on racism and crime (which I think is ridiculous) but I didn’t know either one said anything about advertising. I’d appreciate if you could point me in the right direction on them.

      • Wouter

        Becker & Stigler – De Gustibus Non Est Disputandum, in which there is one part called “IV. Stability of Tastes and Advertising”. That’s their only paper I’ve read, but there’s also a paper by Becker & Murphy called “A Simple Theory of Advertising as a Good or Bad”.

  5. I don’t know if that’s common behavior, but when I have to make a choice between two similar products, one of which is heavily advertised, and another is not, (e.g., Coca Cola vs. store brand cola), with both products priced similarly, I would chose the less-advertised one assuming I don’t have a specific preference for one of them. This is because I have to assume that for the better known brand the portion of the price that’s the advertising expense is higher, and since I don’t personally benefit from that advertising, I’d rather buy a product where that advertising portion is smaller.

    • I’ve heard of people doing that or adbusting, which is not buying things that have been advertised on purpose. Not sure how widespread it is, but probably too small to be a counter balance. You intuition is right and the non-advertised product is almost certainly going to be better value.

      • It’s not necessarily a better value, and I know that: it could have higher profit margins, have more expensive packaging, or include any other cost which isn’t related to the product itself.
        But, as you often mention, we as consumers often make choices based on very limited information, so this estimate of advertising cost could be the only known product attriibute besides price.

  6. Pingback: What is the Economics of Advertising? | Chloe Sargent

  7. Andrey Rosa

    When it comes to ponder about what is the real purpose and value of the Advertising for the society, many people many be out of words to say anything valuable, other may claim that there’s nothing good on advertising. That’s fine, let’s make it clear how much valuable it is. Let’s pretend we all know that if you do not like in Japan or Germany and Canada among others similar, you’ll face many economics crisis because the economy tend to go up and down from time to time, mainly regard the existence of bubble economies. But if we’re under an economic crisis, how can we make out of it? There are many factors and even governmental strategies such as monetary policy that could help, but this time, the advertising is a lot helpful. The over consumption can be bad, mainly because it can pushes exceeded credit request, what in the future will break the financial market, but if people are persuaded to buy different thing they need along different thing they don’t, this can create an opportunity for the industry development, what will generate job creation, and when there are more people working, the trend is to exist more people buying, this way the economy impulse itself into a positive laissez-faire primary generated by the advertising sales force. The share of advertising spending relative to GDP has changed little across large changes in media since 1925. In 1925, the main advertising media in America were newspapers, magazines, signs on streetcars, and outdoor posters. Advertising spending as a share of GDP was about 2.9 percent. By 1998, television and radio had become major advertising media. Nonetheless, advertising spending as a share of GDP was slightly lower – about 2.4 percent. Just to mention another positive feature of advertising for the society, let’ pretend you have a neighbor named Peter. Petter is always busy and even when he’s watching TV for entertainment, he changes the channel everytime the movie has an advertising commercial interruption. Although everytime Petter invites you to have breakfast at his house you notice that he prefers eating bun bread without that brown shell, he loses some precious time unproductively taking it all every time he goes eating a slice of bread. If Peter wasn’t so stubborn, he could have seen that some months ago, the Bread Brazilian Company Wickbold was being massively advertised to promote their non-shell burn, if Petter knew that, he would have bought a non-sheel bun. Advertising also guarantees you that you’ll understand how to use a new product, because it sometimes also works informing you as a salesman. Advertising also guarantee you that among other product in the same segment as that one, this one has some quality level and is recognized as a good ans safe product to consume. Besides the duty to promote new innovative products and creative new ideas, advertising is also a the reason why you and I do not pay for such social network as Facebook or Youtube. What were you thinking? You didn’t you think they were like Facebook.or, didn’t you? Most of the free content websites and social networks among other that you love so much to surf on the internet is only free to acces because of digital advertising. Advertising pays your visit and it guarantee that you’ll be able to google without paying. I think that If I had only used this last Digital Advertising exemple, you’d be already convinced, wouldn’t you? Yes, that’s what I thought.

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