AN EMPIRICAL INQUIRY,
Stanley I. Ornstein and Steven Lustgarten
A basic tenet of traditional industrial organization textbooks holds that large scale advertising expenditures lead to monopoly power.1 Advertising is believed to reduce price elasticity of demand and allow price to be raised above the competitive level. Resulting excess profits are said to persist because of advertising created barriers to entry due to (1) product differentiation or brand loyalty created by advertising and (2) economies of scale in advertising. In addition, supporters of this theory generally conclude that much advertising is misleading and wasteful and that consumers would benefit from restrictions on advertising.2
In contrast to this traditional view, recent literature argues that advertising increases competition3 by providing information to consumers on product quality and characteristics and by allowing new entrants to overcome existing brand loyalties. Advertising helps the more efficient firms expand their market share, thereby resulting in an improved allocation of resources. According to this view, restrictions on advertising are harmful to consumers.
The behavior of the Federal Trade Commission in recent years illustrates these contradictory views on advertising. The FTC has examined restrictions on advertising by physicians, pharmacists, and optometrists____________________