Chapter 4. Advertising in Markets

This chapter proposes an analysis of the role of advertising in the transmission of information in markets. It also describes how the economic analysis of informative advertising provides a satisfactory account of advertising practices and discusses the extent to which resorting to alternative approaches to advertising might be fruitful. In doing so, it provides an overview of what has been identified in the literature as the main incentives of firms to resort to advertising as well as the main arguments pertaining to the welfare economics of advertising. The chapter provides some simplified expositions of the various theories and describes some related empirical literature. The exposition starts with a presentation of the analysis of informative advertising. It is first explained how the informative role of advertising can be understood from the theory of search with particular attention to price advertising. Advertising that contains direct product information is then considered, looking at the nature and the amount of such information provided by advertisers and including some considerations on legal restraints on misleading advertising. Finally, the argument that advertising may provide indirect information in the form of quality signaling or as a coordination device is described and discussed. The chapter then moves on to an analysis of the technology through which advertising conveys information to consumers, considering in turn advertising costs, targeting, and information congestion. The perspective is expanded in the final part of the chapter by allowing advertising to have some role other than the transmission of information. In doing so, the welfare implications of advertising are reconsidered while accounting for a potentially persuasive role of advertising or viewing advertising as a good that complements the advertised product in the consumer's preferences. The strict consumer rationality assumption is also relaxed. The exposition ends with the dynamics of advertising resulting from its role in the accumulation of goodwill for a product or a brand.