More advertising = More consumption?

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.

Special interests vs. the public interest

Yesterday I blogged about experts and special interests groups lobbying for legislation to increase demand for their services.

A recent related example of this can be found in the regional newspaper Kouvolan Sanomat, where a health and construction expert suggested that all buildings should be subject to a inspection system similar to the one currently in place for cars.

This would surely be a great thing for the special interests the expert represents. Whether it would be it for the taxpayer and/or home owners is a different story. Mandatory car inspections can be motivated by the fact that car usage can impose consequences (externalities) on outsiders.  It is not evident that this is the case for houses.

On regulation and impact studies

Frequently papers and news sites report on various groups suggesting that various impact studies should be carried out when any new legislation or regulations are drafted.

Typically this takes the form of experts in the field, say environmental experts suggesting that any new legislation should be analyzed to see what impact the new legislation may have on the environment.

These kinds of impact studies may occasionally make sense. However, critical journalists should point out that calling for systematic impact studies really also (only?) serves the interests of the experts in the field. Mandatory impact studies carries a cost to the taxpayer, while the experts in the field benefits through higher demand for their services.

In order to mitigate this, my suggestions is that all new legislations and regulations should be subject to economic impact studies, or cost-benefit analysis. This suggestion is of course made only in the interest of the taxpayer. Any insinuations that I propose this because it would benefit me as an economist is cynical and daft.

Lobbying for restrictions on competition

Lobbying for restrictions on competition is a really simple phenomenon. It is a bit depressing that journalists reporting on various commerce associations' initiatives for "improving" the workings of the market. Currently, parliamentarians are concerned that instant/quick loans are offered at outrageous terms, in particular that the associated costs are very high. See the article in English at Helsingin Sanomat's website here.

The association of instant loan companies is of opposed to the proposed measures. However, they have a most "helpful" suggestion. They suggest that making instant loans should be a business subject to more regulation and licensing. Today, outrageously enough, anyone can start a instant loan company. This requirement of licensing would of course be in the interest of consumer protection, as the licensing would ensure that only "serious" companies engage in this business.

On the surface, this may sound sensible. But even the slightest scratching of the surface unveils a more plausible reason for the lobbying. Introducing licensing requirements increases the barriers to entry to the market. This reduces competition in the market, increasing profits. The currently active companies are likely to be in a good position to get licensed, as they already know the industry. Apparently they are also good at organizing themselves for lobbying for their industry, which might make it easier to ensure favorable regulation.