The Macroeconomic Relationship between Advertising and Consumption

Abstract

Profit-maximizing firms advertise in order to increase the demand for the goods they produce. Hence, we would expect increases in a firm's advertising to be associated with increases in consumption of the firm's goods, ceteris paribus. The increased demand for the firm's goods may be associated with decreased demand of their rivals' goods. At the market level, increases in advertising by the industry may not be accompanied by increased consumption of the industry's output. This is because changes in the levels of advertising among firms in a particular industry could merely rearrange market shares. If this is true then, in that industry, a firm which increases its advertising relative to its rivals will gain sales at the rivals' expense; advertising in this case is a zero-sum game. When we aggregate across markets to consider advertising at the national level, the question of the effect of advertising upon consumption has still different implications. If increased advertising levels for the economy are associated with increased consumption, this suggests that consumers are increasing current consumption at the expense of future consumption (i.e., savings). If this is true, then advertising affects aggregate consumption and the business cycle. In this paper, we consider the relationship between aggregate advertising and aggregate consumption. While previous research (e.g., Ashley, Granger, and Schmalensee [2] and Schmalensee [24]) has suggested that consumption affects advertising, most previous empirical studies of the causal relationship between aggregate advertising and aggregate consumption reject the hypothesis that advertising affects consumption [6, section 8.3; 12]. An early study was Verdon, McConnell, and Roesler [28], who studied the relationship between advertising and aggregate demand (GNP). While they found advertising to be pro-cyclical and to have a positive effect on aggregate demand, correlations between various leads and lags led them to conclude that no clear pattern existed. This study was followed by Ekelund and Gramm [14], who faulted the Verdon, McConnell, and Roesler study for considering the relationship between advertising and aggregate demand. Instead, Ekelund and Gramm concentrated upon the relationship between advertising and