Optimal Adjustments to Changes in the Price of Advertising

Abstract

It is commonly argued that mandatory reductions in advertising result in decreased consumption of the advertised product and reductions in product price. A prime example is the case of Action for Children's Television (ACT), who throughout the 1970s campaigned to reduce TV advertising of sugared products during children's viewing hours. ACT implicitly claimed that mandatory advertising reductions would reduce the quantity of sugared products consumed by children. This paper shows that this need not be the case. In order to implement mandatory advertising reductions, the FCC would have been forced to set quotas that would have essentially reduced the supply of commercial time during children's shows. Ceteris paribus, this would have raised the market price of advertising during children shows (see Figure 1). As will be shown, corresponding to the higher price of advertising exists a new optimal quantity and price of the advertised product, not necessarily less than their original values. Traditionally, economists (Dorfman and Steiner [3], Franks [6], Needham [11], Ireland and Law [9], Peel [13] and Horowitz [8], just to name a few) have modeled demand by using advertising expenditures as a variable rather than using a measure of the physical quantity of advertising employed by the firm. The models of these are convenient primarily because empirical data on advertising expenditures are readily available for most industries. Yet, the models of the traditionalists are lacking in the following sense. When the price and quantity of advertising are lumped together into one variable, advertising expenditures, the effect of an increase in the price of advertising is unclear. In particular, an increase in the price of advertising reduces the physical quantity of advertising purchased by the firm. Thus, depending on the price elasticity of the firm's demand for advertising, increases (decreases) in advertising expenditures may actually reflect decreases (increases) in the physical quantity of advertising. Since it is the physical quantity of advertising -not advertising expenditures -that alters the demand for a product, traditional models of advertising fail when changes in the price