Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 5 Firm Behavior and the Organization of Industry

Chapter 16 of 36 Monopolistic Competition

Section 12 of 15

…

How does advertising affect the price of a good?

One view: advertising makes consumers view products as being more different than they would view them without advertising.

Markets become less competitive, firms' demand curves become less elastic, more vertical.

By creating a less elastic demand curve (less sensitivity to price) firms can charge a higher price.

Another view: advertising makes it easier for consumers to find the firms offering the best prices and markets become more competitive.

Firms' demand curves are more elastic and firms charge lower prices.

…

Economist Lee Benham tested these two views of advertising in 1972.

In the United States during the 1960s the various states had different laws about advertising by optometrists.

Some states allowed advertising for eyeglasses and eye examinations.

Most states prohibited this advertising.

For example, the Florida law read as follows:

“In the interest of public health, safety, and welfare it is unlawful for any person or firm to advertise any definite or indefinite price or credit terms on prescriptive or corrective lens, frames, or any optometric service.”

Professional optometrists in Florida strongly supported these restrictions on advertising.

The results of Benham’s study were striking.

In states that prohibited advertising the average price for a pair of eyeglasses was $33 ($231 in 2007 dollars)

In states that did not restrict advertising the average price was $26 ($182).

Benham concluded advertising reduced average prices by more than 20 percent.

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