SEPTEMBER 01, 1972 by ISRAEL M. KIRZNER
Dr. Kirzner is Professor of Economics at New York University. He is the author of The Economic Point of View, Market Theory and the Price System, and An Essay on Capital. This article is transcribed from a lecture.
Advertising has been badly treated by many scholars who should know better. Not only Marxists and liberals, but even conservatives have given advertising a bad press. Let us examine some of the criticisms.
· First, many advertising messages are said to be offensive — by esthetic or ethical and moral standards. Unfettered, unhampered, laissez-faire capitalism, it is contended, would propagate such messages in a way that could very well demoralize and offend the tastes and morals of members of society.
· Second, advertising, it is argued, is deceitful, fraudulent, full of lies. Misinformation is spread by advertising, in print, on the airwaves, and this does harm to the members of society; for that reason advertising should be controlled, limited, taxed may.
· Third, it is argued that where advertising is not deceitful, it is at best persuasive. That is, it attempts to change people’s tastes. It attempts not to fulfill the desires of man but to change his desires to fit that which has been produced. The claim of the market economist has always been that the free market generates the flow of production along the lines that satisfy consumer tastes; their tastes determine what shall be produced — briefly, consumer sovereignty. On the contrary, the critics of advertising argue, capitalism has developed into a system where producers produce and then mold men’s minds to buy that which has been produced. Rather than production being governed by consumer sovereignty, quite the reverse: the consumer is governed by producer sovereignty.
· A fourth criticism has been that advertising propagates monopoly and is antithetical to competition. In a competitive economy, it is pointed out, there would be no advertising; each seller would sell as much as he would like to sell without having to convince consumers to buy that which they would not otherwise have bought. So, advertising is made possible by imperfections in the market. More seriously, it is contended, advertising leads toward monopoly by building up a wall of good will, a protective wall of loyalty among consumers which renders a particular product immune to outside competition. Competing products, which do not share in the fruits of the advertising campaign, find themselves on the outside. This barrier to entry may gradually lead a particular producer to control a share of the market which is rendered invulnerable to the winds of outside competition.
· Finally — and this in a way sums up all of these criticisms — advertising is condemned as wasteful. The consumer pays a price for a product which covers a very large sum of money spent on advertising. Advertising does not change the commodity that has been purchased; it could have been produced and sold at a much lower price without the advertising. In other words, resources are being used and paid for by the consumer without his receiving anything that he could not have received in their absence.
These are serious criticisms. We have learned to expect them to be emphasized by contemporary liberal economists. To Marxist thinkers, again, advertising is essential for capitalism; it is seen as a socially useless device necessary in order to get excess production sold. They see no positive elements in advertising at all. But even conservative thinkers and economists have pointed out some apparent limitations, weaknesses, criticisms of advertising.
The Free Economy and How It Functions
It is not my purpose here to defend each and every advertising message. I would rather discuss a free economy, a laissez-faire economy, pure capitalism. I would like to show that in such a world, advertising would emerge with a positive role to play; that it would add to the efficiency with which consumer wants are satisfied; and that, while the real world is far from perfect, a large volume of the criticism would fade away were it understood what role advertising, in fact, has to play in a pure market economy.
Let me imagine a world, a free market, in which there are no deceitful men at all. All the messages beamed to consumers and prospective consumers would be, as far as the advertisers themselves believe, the strict truth. We will consider later the implications of the fact that men are imperfect and that men succumb to the temptation in selling something to say a little bit less, a little bit more, than the exact truth. In the meantime, let us talk about a world of honest men, men who do not try to deceive.
Further, let us imagine a pure market economy with government intervention kept to the absolute minimum — the night watchman role. The government stands to the sidelines and ensures the protection of private property rights, the enforcement of contracts freely entered into. Everyone then proceeds to play the game of the free market economy with producers producing that which they believe can be sold to the consumers at the highest possible money price. Entrepreneur producers, who detect where resources are currently being used in less than optimum fashion, take these resources and transfer them to other uses in the economy where they will serve consumer wants which the entrepreneurs believe are more urgently desired, as measured by the amounts of money consumers are willing to pay for various products.
We will assume that there is freedom of entry into all industries. No entrepreneur has sole control over any resource that is uniquely necessary for the production of a given product. No government licenses are required in order to enter into the practice of a given profession or to introduce a particular product. All entrepreneurs are free to produce what they believe to be profitable. All resource owners are free to sell their resources, whether labor, natural resources, capital goods. They are free to sell or rent these resources to the highest bidder. In this way the agitation of the market gradually shuffles resources around until they begin to be used to produce those products which consumers value most highly. Consumers arrange their spending to buy the commodities they believe to be most urgently needed by themselves. And the market flows on in the way that we understand it.
We say this is a free market, a laissez-faire, competitive system. But we do not mean a perfectly competitive market, as this notion has been developed by the neo-classical economists. In a perfectly competitive market, each seller faces a demand curve which is perfectly horizontal. That is to say, each seller believes that he can sell as much as he would like to sell without having to lower the price. Each buyer faces a perfectly horizontal supply curve and each buyer believes that he can buy as much as he would like to buy of anything without having to offer a higher price. In such a world of "perfect competition," we have what we call an "equilibrium" situation, that is a situation where all things have already been fully adjusted to one another. All activities, all decisions have been fully coordinated by the market so that there are no disappointments. No participant in the economy discovers that he could have done something better. No participant in the economy discovers that he has made plans to do something which it turns out he cannot do.
In this model of the perfectly competitive economy, there would in fact be no competition in the sense in which the layman, or the businessman, understands the term. The term "competition" to the businessman, the layman, means an activity designed to outstrip one’s competitors, a rivalrous activity designed to get ahead of one’s colleagues, or those with whom one is competing. In a world of equilibrium, a world of "perfect competition," there would be no room for further rivalry. There would be no reason to attempt to do something better than is currently being done. There would, in fact, be no competition in the everyday sense of the term.
When we describe the laissez-faire economy as competitive, we mean something quite different. We mean an economy in which there is complete freedom of entry; if anyone believes that he can produce something that can serve consumers’ wants more faithfully, he can try to do it. If anyone believes that the current producers are producing at a price which is too high, then he is free to try to produce and sell at a lower price. This is what competition means. It does not mean that the market has already attained the "equilibrium" situation, which goes under the very embarrassing technical name of "perfectly competitive economy."
Now, economists and others understand generally that competition means price competition: offering to sell at a lower price than your competitors are asking, or offering to buy at a higher price than your competitors are bidding. Entrepreneurs will offer higher prices than others are offering for scarce labor. They will offer to sell a product at lower prices than the competing store is asking. This is what price competition means. This is the most obvious form in which competition manifests itself.
However, we must remember that there is another kind of competition, sometimes called "non-price competition," sometimes called "quality competition." Competition takes the form not only of producing the identical product which your competitors are producing and selling it at a lower price, not only in buying the identical resource which your competitors are buying and offering a higher price. Competition means sometimes offering a better product, or perhaps an inferior product, a product which is more in line with what the entrepreneur believes consumers are in fact desirous of purchasing. It means producing a different model of a product, a different quality, putting it in a different package, selling it in a store with a different kind of lighting, selling it along with an offer of free parking, selling through salesmen who smile more genuinely, more sincerely. It means competing in many, many ways besides the pure price which is asked of the consumer in monetary terms.
With freedom of entry, every entrepreneur is free to choose the exact package, the exact opportunity which he will lay before the public. Each opportunity, each package has many dimensions. He can choose the specifications for his package by changing many, many of these variables. The precise opportunity that he will lay before the public will be that which, in his opinion, is more urgently desired by the consumer as compared with that which happens to be produced by others. So long as there’s freedom of entry, the fact that my product is different from his does not mean that I am a monopolist.
A Disservice to Economics
The late Professor Edward H. Chamberlin of Harvard did economics a great disservice in arguing that because a producer is producing a unique product, slightly different from what the fellow across the street is producing, in some sense he is a monopolist. So long as there’s freedom of entry, so long as the man across the road can do exactly what I’m doing, the fact that he is not doing exactly what I’m doing is simply the result of his different entrepreneurial judgment. He believes that he can do better with his model. I believe I can do better with mine. I believe that free parking is more important to consumers than fancy lighting in the store. He gives a different package than I do. Not because he couldn’t do what I’m doing, not because I couldn’t do what he’s doing, but because each believes that he knows better what the consumer is most anxious to acquire. This is what we mean by competition in the broadest sense, not merely price competition, but quality competition in its manifold possible manifestations.
Professor Chamberlin popularized a distinction which was not original with him but which owes its present widely circulated popularity primarily to his work. That is a distinction between "production costs" and "selling costs." In his book of almost forty years ago, The Theory of Monopolistic Competition, Chamberlin argued that there are two kinds of costs which manufacturers, producers, sellers, suppliers incur. First, they incur the fabrication costs, the costs of producing what it is they want to sell. Second, they incur additional expenditures that do not produce the product or change it or improve it, but merely get it sold. Advertising, of course, is the most obvious example which Chamberlin cited. But "selling costs" of all kinds were considered by him to be sharply different from "production costs." In his original formulation, Chamberlin argued that "production costs" are costs incurred to produce the product for a given Demand Curve while "selling costs" simply shift the Demand Curve over to the right. That is to say, the same product is now purchased in greater quantities at a given price but the product is the same.
A False Distinction
The fallacy in the distinction between production costs and selling costs is fairly easy to notice. In fact, it is impossible for the outside observer — except as he resorts to arbitrary judgments of value — to distinguish between expenditures which do, and expenditures which do not, alter the product. We know as economists that a product is not an objective quantity of steel or paper. A product is that which is perceived, understood, desired by a consumer. If there are two products otherwise similar to the outside eye which happen to be considered to be different products by the consumer, then to the economist these are different products.
Ludwig von Mises gives the example, which cannot be improved upon, of eating in a restaurant. A man has a choice of two restaurants, serving identical meals, identical food. But in one restaurant they haven’t swept the floor for six weeks. The meals are the same. The food is the same. How shall be describe the money spent by the other restaurant in sweeping the floor? "Production costs” or "selling costs?" Does sweeping change the food? No. Surely, then, it could be argued that this is strictly a "selling cost." It is like advertising. The food remains the same; but, because you have a man sweeping out the floor, more people come to this restaurant than to that. But this is nonsense. What you buy when you enter a restaurant is not the food alone. What you buy is a meal, served in certain surroundings. If the surroundings are more desirable, it’s a different meal, it’s a different package. That which has been spent to change the package is as much production cost as the salary paid to the cook; no difference.
Another example that I recall was the case of the coal being run out of Newcastle and traveling along the railroad toward London. Every mile that coal travels nearer the London drawing room, the Demand Curve shifts over to the right. How shall we describe that transportation cost? "Production cost" or "selling cost?" Of course, it’s "production cost." In fact, it’s "selling cost" too. All "production costs" are "selling costs." All costs of production are incurred in order to produce something which will be more desirable than the raw materials.
You take raw meat and turn it into cooked steak. The act of changing the raw meat into cooked steak is to make the consumer desire it more eagerly. Does this simply shift the Demand Curve over to the right? Of course, it does that. It does it by changing the product.
Another example supposes there are two identical pieces of steel, except that one piece has been blessed, while the other piece is subject to a spiritual taint, which to the scientist is not there but which is very vivid and vital to the consumer. How shall we describe the expenditure on the commodities? Shall be describe the difference between them as nonexistent? Or should we not recognize that, if something is spiritually tainted to the consumer —in his view, not necessarily in mine or yours or the economist’s or other than in the mind of the consumer — then he will not buy the tainted item, even though to the objective laboratory scientist there’s no difference between the items? The economist has recognized these as two different commodities. There’ll be two Demand Curves. The fact that the scientist doesn’t see any difference — they look the same, they smell the same, if you touch them they feel the same — is irrelevant. We know, as economists, that what we find in a commodity is not the objective matter that is inside it, but how it is received by the consumer.
Clearly then, the distinction between a so-called "selling cost" and "production cost" is quite arbitrary. It depends entirely on the value judgments of the outside observer. The outside observer can say that this particular selling effort does not change the product, but in that situation he is arrogating to himself the prerogative of pronouncing what is and what is not a product. That is something which violates our fundamental notions of individual consumer freedom: that a consumer’s needs are defined by no one else other than himself. This may seem quite a detour from advertising and yet it is all relevant to the question of what role advertising has to play.
The Provision of Information
Let us consider how some of these notions apply to the matter of information. One of the standard defenses for advertising is that it provides a service which consumers value the provision of knowledge, the provision of information. People buy books. People go to college. People enroll in all kinds of courses. Advertising is simply another way of providing information. To be sure, it would seem that the information provided by suppliers comes from a tainted source, but don’t forget that we are imagining for the meantime a world without deceitful people.
We can even relax that assumption for a moment. It may be cheaper for the consumer to get his information from the supplier or the producer than from an outside source. In other words, if you, a consumer, have the choice of acquiring information about a particular product — either more cheaply from the producer or more expensively from an outside, "objective" source — you may decide that, on balance, you’re likely to get a better deal, penny-for-penny, information-wise, by reading the information of the producer, scanning it perhaps with some skepticism, but nonetheless relying on that rather than buying it from an outside source. Technically, this involves what is known as the problem of transactions costs. It may be more economical for the information to be packaged together with the product, or at least to be produced jointly with the product, than to have the information produced and communicated by an outside source. This is a possibility not to be ignored.
Advertising provides information, and this goes a long way to explain the role which advertising and other kinds of selling efforts must play. Does this not seem to contradict the point just made, that there is no distinction between "production costs" and "selling costs"? Surely information about a product is distinct from the product. Surely the costs incurred to provide information are a different kind of costs than the costs incurred to produce the product. The answer is clearly, no. Information is produced; it is desired; it is a product; it is purchased jointly with the product itself; it is a part of the package; and it is something which consumers value. Its provision is not something performed on the outside that makes people consume something which they would not have consumed before. It is something for which people are willing to pay; it is a service.
You can distinguish different parts of a service. You can distinguish between four wheels and a car. But the four wheels are complementary commodities. That is to say, the usefulness of the one is virtually nil without the availability of the other. The car and gasoline are two separate products, to be sure, and yet they are purchased jointly, perhaps from different producers, different suppliers, but they are nonetheless parts of a total package, a total product. If it happens that the information is produced and sold jointly with the product itself, then we have no reason to question the characteristics of the costs of providing information as true "production costs," not producing necessarily the physical commodity about which information is produced, but producing information which is independently desired by consumers, independently but jointly demanded, complementarily used together with the "product" itself. In other words, the service of providing information is the service of providing something which is needed just as importantly as the "product" itself.
Why the Shouting?
There is another aspect of advertising which is often overlooked. Information is exceedingly important. But, surely, it is argued, information can be provided without the characteristics of advertising that we know, without the color, without the emotion, without the offensive aspects of advertising. Surely information can be provided in simple straightforward terms. The address of this and this store is this and this place. These and these qualities of commodities are available at these and these prices. Why do illustrated advertising messages have to be projected? Why do all kinds of obviously uninformative matter have to be introduced into advertising messages? This is what renders the information aspects of advertising so suspect. The Marxists simply laugh it away. They say it is ridiculous to contend that advertising provides any kind of genuine information. If one rests the defense of advertising on its informative role, then one has a lot of explaining to do. One has to explain why information that could be provided in clear cut, straightforward terms is provided in such garish and loud forms, in the way that we know it.
The answer, I think, is that advertising does much more than provide information which the consumer wishes to have. This is something which is often overlooked, even by economists. Supposing I set up a gas station. I buy gasoline and I have it poured into my cellar, my tanks. I have a pump carefully hidden behind some bushes, and cars that come down the road can buy gas if they know that I’m here. But I don’t go to the effort to let them know I’m here. I don’t put out a sign. Well, gas without information is like a car without gas. Information is a service required complementarily with the gas.
Customers Want to Know Where to Find the Product
Supposing, then, I take a piece of paper, type very neatly in capital letters, "GAS," and stick it on my door. Cars speed down the road in need of gas, but they don’t stop to read my sign. What is missing here? Information is missing. Don’t people want information? Yes. They would like to know where the gas station is, but it’s a well kept secret. Now, people are looking for that information. It’s my task as an entrepreneur not only to have gas available but to have it in a form which is known to consumers. It is my task to supply gas-which-is-known-about, not to provide gas and information.
I have not only to produce opportunities which are available to consumers; I have to make consumers aware of these opportunities. This is a point which is often overlooked. An opportunity which is not known, an opportunity to which a consumer is not fully awakened, is simply not an opportunity. I am not fulfilling my entrepreneurial task unless I project to the consumer the awareness of the opportunity. How do I do that? I do that, not with a little sign on my door, but with a big neon sign, saying GAS; and better than that I chalk up the price; and better than that I make sure that the price is lower than the price at nearby stations; and I do all the other things that are necessary to make the consumer fully aware of the opportunity that I am in fact prepared to put before him. In other words, the final package consists not only of abstract academic information but in having the final product placed in front of the consumer in such a form that he cannot miss it. Free $10 Bills!
The strange thing about the world in which we live is that it is a world in which $10 bills are floating around, free $10 bills! The problem is that very few of us notice these $10 bills. It is the role of the entrepreneur to notice the existence of $10 bills. An entrepreneur buys resources for $10 and he sells the product for $20. He is aware that resources available for $10 are currently being used in less than optimum fashion, that commodities for which consumers are willing to pay $20 are not being produced, and he puts these things together. He sees the $10 bill and makes the combination which other people do not see. Anybody might do it — freedom of entry. The entrepreneur notices the $10 bill, gets it for himself by placing in front of the consumer something which he had not noticed. If the consumer knew where he could buy resources for $10 and get the product that is worth $20, he wouldn’t buy from the entrepreneur. He would do it himself. Since he doesn’t know, I, as entrepreneur, have to create this opportunity and make the consumer aware.
It is not enough to buy gas and put it in the ground. The entrepreneur puts it in the ground in a form that the consumer recognizes. To do this requires much more than fabrication. It requires communication. It requires more than simple information. It requires more than writing a book, publishing it, and having it on a library shelf. It requires more than putting something in a newspaper in a classified ad and expecting the consumer to see it. You have to put it in front of the consumer in a form that he will see. Otherwise, you’re not performing your entrepreneurial task.
The Growth of Advertising
Advertising has grown. Compare the volume of advertising today with the volume of 100 years ago and it has grown tremendously. More! Consider the price of a commodity that you buy in a drug store or in a supermarket. Find out what portion of that price can be attributed to advertising costs and it turns out that a much larger percentage of the final cost to the consumer can be attributed to advertising today than could have been attributed 50 years ago, 70 years ago, 100 years ago. Why is this? Why has advertising expenditure grown in proportion to total value of output? Why has advertising expenditure grown in proportion to the price of a finished commodity? Why has advertising apparently grown more offensive, more loud, more shrill? It’s fairly easy to understand.
I give, as example, the lobby walls of a college building that I know very well. At one time this was a handsome lobby with walls of thick marble; you could walk from one end of the building to the other and the walls would be clear. Some years ago an enterprising entrepreneur decided to use some free advertising space. He pasted up a sign. It was the only sign on the wall; everybody looked at it, saw the message. I don’t remember what the message was or whether it was torn down, but I do remember that soon afterward those walls were full of signs. As you walked down the passage, you could read all kinds of messages, all kinds of student activities, non-student activities, student non-activities. It was fairly easy to learn about what was going on simply by reading the signs.
At first, the signs did not have o be big. But as advertisers saw the opportunity, the free space gradually filled up. The Ricardian rent theory came into play; all the free land was in use. And as the free land or space was taken, of course, it became more and more important to get up early to paste up your sign. That was the "rent," the high price, getting up early. But more than that, it became necessary now to arouse all kinds of interest in me in order to get me to read these signs. In other words, the variety and multiplicity of messages make it harder and harder to get a hearing.
The Price of Affluence
We live in a world which is often described as an "affluent society." An affluent society is one in which there are many, many opportunities placed before consumers. The consumer enters a supermarket and if he is to make a sensible, intelligent decision he is going to have to spend several hours calculating very carefully, reading, rereading everything that’s on the packages and doing a complete research job before feeding all the information into the computer and waiting for the optimum package to be read off. It’s a tough job to be a consumer. And the multiplicity of opportunities makes it necessary for advertisers, for producers, to project more and more provocative messages if they want to be heard. This is a cost of affluence. It is a cost, certainly; something that we’d much rather do without, if we could; but we can’t.
The number of commodities that have been produced is so great that in order for any one particular product to be brought to the attention of the consumer a large volume of advertising is necessary. And we can expect to get more and more. Is it part of production costs? Very definitely, yes. It is completely arbitrary for anyone to argue that, whether or not the consumer knows it, the commodity is there anyway, so that when he pays the price which includes the advertising communication he is paying more than is necessary for the opportunity made available. For an opportunity to be made available, it must be in a form which it is impossible to miss. And this is what advertising is all about.
One more word about the offensiveness of advertising. Ultimately in a free market, consumers tend to get what they want. The kinds of products produced will reflect the desires of the consumer. A society which wants moral objects will get moral objects. A society which wants immoral objects will tend to get immoral objects. Advertised communication is part of the total package produced and made available to consumers. The kind of advertising we get, sad to say, is what we deserve. The kind of advertising we get reflects the kind of people that we are. No doubt, a different kind of advertising would be better, more moral, more ethical in many respects; but I’m afraid we have no one to blame but ourselves, as in all cases where one deplores that which is produced by a market society.
A final word about deceit. Of course, deceitful advertising is to be condemned on both moral and economic grounds. But we have to put it in perspective. Let me read from one very eminent economist who writes as follows:
The formation of wants is a complex process. No doubt wants are modified by Madison Avenue. They are modified by Washington, by the university faculties and by churches. And it is not at all clear that Madison Avenue has the advantage when it comes to false claims and exaggerations.1
Take with a Grain of Salt
In other words, we live in a world where you have to be careful what you read, to whom you listen, whom to believe. And it’s true of everything, every aspect of life. If one were to believe everything projected at him, he would be in a sorry state.
It is very easy to pick out the wrong messages to believe. Now, this doesn’t in any way condone or justify deceitful messages of any kind. We have to recognize, however, while particular producers may have a short-run interest in projecting a message to consumers of doubtful veracity, that so long as there’s freedom of competition the consumer has his choice not only of which product to buy but who to believe. And notice what is the alternative in this world of imperfect human beings. The alternative, of course, is government control — still by imperfect human beings. So there is no way to render oneself invulnerable to the possibility of false, fraudulent, deceitful messages.
It would be nice to live in a world where no deceitful men were present. It would be cheaper. You could believe any message received. You wouldn’t have to check out the credentials of every advertiser. But that is not the world in which we live. You check out the credit standing of individuals, the character of people with whom you deal; and this is an unavoidable, necessary cost. To blame advertising for the imperfections and weaknesses of mankind is unfair. Advertising would exist under any type of free market system. Advertising would be less deceitful if men were less deceitful. It would be more ethical, less offensive, if men were less offensive and more ethical. But advertising itself is an integral, inescapable aspect of the market economy.
1 H. Demsetz, "The Technostructure, Forty-Six Years Later," (Yale Law Journal, 1968), p. 810.