A debate
about alcohol advertising is going on in Finland currently. Those who want to
reduce overall alcohol consumption argue for banning image promoting advertising (eg. The suggestion
that a fox will be sexually more successful if it drinks a certain brand of
cider – yes this particular ad was already forbidden). Will this reduce overall
consumption?
The easy answer might seem to be yes. The argument used by many
who promote this view (lets call them the “pro ban” people) is what an economist would
call a revealed preference argument. The fact that firms advertise suggests
that advertising increases profits. From this those in favor of a ban conclude
that advertising must increase demand, thereby increasing the total quantity
consumed. If this was not the case, then the firms would not advertise.
This
argument has a superficial appeal of logic (and economics). At least until we
study it more intensely. The fact that individual firms choose to advertise
does not mean that this increases the total quantity that eventually is consumed.
One easy,
albeit perhaps not entirely realistic hypothetical case that disproves the pro
ban argument is one whereby producers compete for existing consumers. By
advertising, producer A seeks to get those who used to buy from B to buy from A
instead. In this situation the only effect of advertising is to shift demand
from one producer to the other producer. Total quantity consumed stays
constant.
Lets make
the picture a bit more nuanced. Assume that firms seek to differentiate themselves from
each other through advertising (eg. the sexually successful fox case), but at
the same time advertising expands the total market. By differentiating himself
from A, B can charge a higher price, as consumers now perceive B to be
something different from A. Simultaneously, A can also increase advertising, in
order to increase demand facing him. With A and B differentiated from each
other thanks to advertising, each can charge a higher price. For a given
demand, this means lower realized consumption. Call this setup the advertising
induced differentiation setup.
On the
other hand, if we ban advertising, then the producers will need to compete on
price, instead of on image. This results in a lower price, and thus for a given
demand increased realized consumption.
Thus we see
that the effect of ban on advertising is not unambiguous. To sort out the
effect, we need more information.
Lets assume that advertising increases the
total potential market size. If this is the case, while consumers’ price
elasticity of demand doesn’t change too much, then realized consumption is
indeed higher under advertising induced differentiation.
However, if
advertising affects consumers’ price elasticity of demand enough (making consumers
less sensitive to changes in price), while potential market size stays the same
(or doesn't increase too much), then the realized consumption will be lower
under advertising induced differentiation.
Thus, it
all depends. The reason that advertising can decrease total consumption is that
advertising can differentiate products, giving their producers market power,
and thus an incentive to limit production so as to increase prices, in order to
increase profits.
