THE IMPACT OF ADVERTISING ON CONSUMPTION: New aggregate evidence
01 Aug 2018
Because of advertising, people work more to consume more. According to research by Benedetto Molinari and Francesco Turino, published in the August 2018 issue of the Economic Journal, this leaves them unambiguously worse off because the overworking effect is stronger than the expansion in consumption. Their study analyses the economy-wide effects of aggregate advertising in the United States over the period 1970 to 2007.
The researchers note that the need to advertise products is a key feature of modern economies, one that has been intrinsically related to firms’ business practices since the Industrial Revolution. Indeed, advertising and marketing practices more generally have been of equal importance for firms as production and technological innovation.
A large amount of money is spent on this activity. For example, in the US market just before the financial crisis, firms spent up to $272 billion to advertise their products in the media, approximately $1,200 dollars per citizen. The US advertising industry accounts for 2.2% of GDP, absorbing approximately 20% of firms’ budgets for new investments and using 16% of their corporate profits.
Traditionally, the rationale for firms’ spending on advertising has been identified as the positive effect of advertisements on sales. Firms realise that the demand they face is not an exogenous product of consumers’ preferences; instead, it can be tilted toward their own products through advertisements.
Building on this fact, the authors of the new study ask whether such a relationship holds in the aggregate:
• Because the reason for advertising is to increase consumers’ demand, as targeted advertising increases the sales of single goods, will aggregate advertising enhance aggregate consumption?
• If so, will it also increase aggregate demand and production?
• In other words, how important are the spillover effects from the advertising sector to economic activity?
Their analysis provides answers to these questions. The US economy during the period 1970-2007 is taken as reference, and the economy-wide effects of aggregate advertising are disentangled. The authors argue that advertising exacerbates the fluctuations of economic activity, and makes the economy more consumption-based by raising the weight of consumption in GDP.
The underlying mechanism operates through a work and spend channel: because of advertising, people work more to consume more and the perceived need for additional consumption results from advertising signals to which they are exposed.
The authors show that this mechanism makes consumers unambiguously worse off because the overworking effect is stronger than the expansion in consumption. As a result, banning advertising would be welfare-enhancing.
‘Advertising and Aggregate Consumption: A Bayesian DSGE Assessment’ by Benedetto Molinari and Francesco Turino is published in the August 2018 issue of the Economic Journal.