Who Benefits from Misleading Advertising?

Abstract

Considering a model of price and misleading advertising competition between two brands producing horizontally and vertically differentiated brands, we investigate allocative implications of misinformation and related regulatory policies. Although misinformation distorts consumers' decision‐making, misinformation can correct inefficiencies resulting from misallocation of goods, thereby increasing welfare. However, advertising competition may create a prisoner's dilemma for firms and reduce welfare, but smart consumers unaffected by misinformation and consumers preferring low‐quality brands may gain. We also demonstrate how a biased policymaker who places different weights on producers' and consumers' surpluses behaves in response to misinformation disseminated by firms.