The above argument shows that, in order for advertising to generate some social sur-
plus, search costs must be large. Indeed, with low search costs, the threshold utility is very
large and most consumers have utility levels with both products that lie below. Then the
only benefit from being exposed to advertising is a cut in search costs. If search costs are
low, the benefits are low as well. Now if search costs are low, firms do not benefit much
from advertising. Consumers end up making a perfectly informed choice whether or not
they receive ads. This suggests that with differentiated products, it is not clear that if con-
sumers are allowed to search there will be excessive advertising as is the case for a homo-
geneous product.
4.2.6 Concluding Remarks
Because consumers face search costs, advertising is a socially beneficial activity. This point
was first made by
Stigler (1961) and is reinforced by the Diamond paradox that tells us
that, with no advertising, we would get the monopoly outcome or even complete market
unraveling. For homogeneous products, consumer search is motivated by the dispersion
in prices and, indeed, the interaction of search and advertising yields price dispersion. Yet
there is no search in equilibrium because all prices are low enough that consumers prefer
not to search. However, advertising concerns for the most part markets with differenti-
ated products. On these markets, consumers search for appropriate products as well as low
prices and typically they do engage in search when they do not receive advertising from
some of the sellers.
Now that a growing share of the advertising market, including advertising on online
media, is on the Internet, search and advertising are much more intertwined and search
costs are much smaller. Shoppers on the Internet may be exposed to ads and users of web-
sites that provide such contents as news or entertainment may become immediate shop-
pers by clicking on an ad.
18
New forms of advertising have emerged, notably search
advertising whereby sellers bid to obtain sponsored links that are in favorable positions
on a search engine.
19
These new practices also illustrate that one important role of adver-
tising is to direct consumer search, whereas the great majority of the analysis of consumer
search assumes random search. There is a growing theoretical literature on ordered con-
sumer search, including
Arbatskaya (2007), Armstrong et al. (2009), Zhou (2011)), Haan
and Moraga-Gonza
ยด
lez (2011)
, and Anderson and Renault (2015).
Advertising being socially valuable does not mean it is provided optimally by the mar-
ket. It may be under-provided because of the non-appropriation of consumer surplus by
advertisers or excessive because of the market-stealing externality on other advertisers.
For a homogeneous product, there is an argument suggesting it is under-provided,
18
See Renault (2014) for a framework that captures these features.
19
Studies of search advertising include Varian (2007), Edelman et al. (2007), Athey and Ellison (2011), Chen
and He (2011)
, De Cornie
`
re (2013), and Anderson and Renault (2015).
142
Handbook of Media Economics
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