Law and Economics (Optional) | Project

AN ECONOMIC ANALYSIS OF ADVERTISEMENT REGULATIONS

Indrajeet Sircar (I.D. 208013)

I. INTRODUCTION

The concept of consumer choice is one of the most central concepts to the economic notion of
allocative efficiency. In a scenario where all available resources are moved to their highest
valued uses, a choice between various alternatives has to be exercised, and this choice is
fuelled by a number of preferences expressed by the consumers.1 But the aforementioned
model of expressed preferences leading to allocative efficiency, is dependent on two crucial
assumptions: (a) that the decision makers have sufficient information on the sets of
alternatives available to them ; (b) that pursuant to the availability of such information, the
decision makers will behave rationally, in order to maximise the expected utility.2

The first assumption with regards sufficiency of information, as can be inferred from real
world scenarios, is the exception and not the general norm. This lack of information and the
subsequent costs incurred in obtaining the same is the scope of operation of advertisements.3
The second assumption with regards maximising expected equality considered in tandem
with the operation of advertisements forms the domain of operation for regulations.4

In many real life situations, an evident lack of information leads to the incurring of further
costs.5 This can be illustrated by an example where Person A wants to trade his car with a
new car of a particular model and this costs him a sum (S1). The question as to whether he
should proceed to make the transaction in the first instance or obtain comparable information
from other dealers is dependent on the difference of cost between the offers (S1 – S2 = D), the

1
Ogus A., “Regulation: Legal Form and Economic Theory” (Hart Publishing, 2004) at pp.29-54
2
Ibid.
3
Ibid.
4
Ibid.
5
Lee B., “The Effect of Advertising on the Price of Eyeglasses” 15 J.L. & Econ. 337 1972; The full cost of

purchase (Cf) of a good to a consumer includes not only the cost of the item itself (Cg) but the cost of knowledge

(Ck) concerning the location of sales outlets and prices and the cost of time and transportation required to

purchase the time: Cf = Cg + Ck + Ct

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probability (p) of the second offer being less than the first one and the marginal costs (MC)
incurred in terms of travel and time. If A is to proceed to the next dealer, the relation between
these factors in a rational framework should be –

p ( D ) > MC

That is, if the probability of the cost difference being positive is greater than the marginal
costs, the marginal benefits derived will be greater. When this condition ceases to exist, the
rational choice should be not to seek comparable information.

Costs incurred by consumers for acquiring adequate information with regards purchasing
decisions, such as the ones referred to in the preceding paragraph are often substantial. But
sellers on the other hand can provide the same information more cheaply because economies
of scale are involved and, in a competitive market, they have an incentive to do this by the
way of advertising, in order to distinguish their products from those of their competitors.
There are, however several factors which may distort the construct of these incentives.6

This paper deals with ascertainment of such distortions and tries to determine the scope for
regulations in such a construct. It then moves on to determine the need for regulations in its
potential domain of operation and subsequently evaluates the effects of such regulations from
an economic perspective and compares such methods against the efficacy of self-regulation.
Lastly, it analyses the legal provisions under the Indian legal system which seek to regulate
information, and evaluates the very need for such regulations and their efficacy in
maintaining an optimal allocation of resources.

II. SCOPE AND NEED FOR REGULATION OF INFORMATION AND ADVERTISMENT

The incentives that lie with the seller‟s in the process of advertising often get blunted or
distorted due to the existence of an imperfect competition.7 It is argued that it is at these
points that regulations might have a prima facie requirement.

Information, by virtue of it being in the nature of a public good (that is, it is difficult at low
cost to restrict its transmission to those who directly or indirectly pay for it and consumption
by one user does not lower its value for other users), implies that there will be an under

6
Supra Note.1
7
Kirkpatrick J., “In Defense of Advertising” (TLJ Books, 2nd Ed., 2006) at p. 120
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provision of such information in the unregulated markets. Hence, in this sense, the existence
of regulations in the market helps in removing asymmetry of information.8

Further, a seller in his efforts to distinguish one of his products from those of his competitors
may create an „artificial product differentiation‟ pursuant to which, potential buyers are led to
believe that a particular commodity has special characteristics which either do not exist or are
insignificant in relation to its use or consumption.9 An economically undesirable consequence
of this is that the seller obtains a certain degree of monopolistic control over the product‟s
market. Similarly, a seller in furtherance of the incentives of advertising may supply false or
misleading information, as well as accurate information, if he believes that doing so will
enhance his profits.

Now, in the aforementioned domain of operation there can be three types of regulations, viz.
regulation of price advertising, regulation on the basis of characteristic goods and lastly
regulation by means of mandated disclosure. The following section analyses in details each of
the three regulatory methods.

III. ECONOMIC REPERCUSSIONS OF REGULATION OF ADVERTISEMENTS

The regulation of advertisements in general is pursued through the following methods.

A. REGULATION OF PRICE ADVERTISING

Regulation of price advertising is primarily with the motive of preventing the occurrence of
„deceptive pricing‟. An illustration of such a claim is, “Available for `100 elsewhere;
Available for `75 here.” It must be noted here that a pre-condition to the presumption of this
being a deceptive claim of pricing is that there have not been enough sales at the reference
price of `100.10 If the case is akin to the later scenario, where there has been such a claim
without the existence of sufficient sales at the reference pricing, the consumer is not given
newer options.

8
Supra Note. 1
9
Ibid.
10
Rubin P.H. , “Information Regulation (Including Regulation of Advertising”, Encyclopaedia of Law and

Economics, Volume – III: Regulation of Contracts, Ed. Bouckaert B. Geest G.D. (Edward Elgar Publishing,

2000) at p.273
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In a scenario like the one mentioned above, if regulations are not present, it is suggested that
the process initiated by such an advertisement will actually end up benefiting the
consumers.11 Owing to the existence of a certain amount of information pertaining to the
distribution of the product‟s prices in the market among the consumers, other sellers, in a
competitive scenario, will have to lower their prices. Eventually, the seller initially
advertising the product might have to lower prices further.12 If in this case there were existent
regulations which restricted such a representation of prices, the prices would have remained
at their initial mark. The main observation here being that generally when a market is in a
high-priced disequilibrium, it is stabilised and brought down to a low priced equilibrium by
advertisements even if they might appear to be deceptive.13 The preceding scenario holds
valid in small markets with limited number of suppliers. In large markets where there are
many suppliers and the demand is proportionately higher, assuming that there exists no
asymmetry of information pertaining to comparative advertising amongst the suppliers, the
impact of the same gets amplified.14

Empirical studies have shown that prices of products and services such as eyeglasses, legal
services, advertising of prescription drugs by pharmacists, and retail gasoline price posting,
and on toy advertising directed at children, are lower where advertising is allowed, as
compared to markets where advertising is completely prohibited.15

B. REGULATION BASED ON CHARACTERISTICS OF GOODS

It is argued by economists that the primary morale behind regulation of information should be
the effect such information has on consumer welfare. Based on this premise there exists three
clearly demarcated characteristics of goods with respect to advertising. These are “search”,
“experience” and “credence” characteristics.16

11
Ibid.
12
Ibid.
13
Ibid.; See also Schwartz A., Wilde L.L., “Intervening In Markets on the Basis of Imperfect Information: A

Legal and Economic Analysis” 127 U. Pa. L. Rev. 630;

14
Ibid.
15
Supra Note. 7 at p.1374-5
16
Supra Note. 10
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Search characteristics are those characteristics which can be determined before the associated
good is purchased. The experience characteristics of a good are those which can be evaluated
only after having used the goods. Credence characteristics of a good are those characteristics
the existence of which cannot be ascertained even after purchase.17

As is obvious, there is no need for regulation with regards search characteristics of a good, as
these can be determined by the consumer in the process of making the purchase. Transaction
price of a good is a search characteristic and hence regulation with regards to pricing is
detrimental to the attainment of a stable equilibrium in the market.18

With regards the experience characteristics of goods, the costs incurred by deception will be
much lower in the case of inexpensive goods, as the consumer might be deceived with
regards the experience characteristics at most once. But in the case of expensive goods‟
experience characteristics the losses will be greater.19 It is suggested that regulations be
restricted to only the later class of expensive experience goods as opposed to the former class
of inexpensive goods.20

An example of credence good is unnecessary repair of a gadget. The consumer cannot really
ascertain the truth of claims, as the gadget would keep on functioning properly even after the
repairs. In cases such as these, where consumers cannot evaluate the truth of a claim even
after using the product or service, the potential for deceptive claims is greater.21 Regulatory
intervention in such instances can enhance market performance.22

C. REGULATION BY MANDATED DISCLOSURE

17
Ibid.
18
See Discussion under Section III A above.
19
Supra Note. 10; See also Schmalensee R., “A Model of Advertising and Product Quality”, The Journal of

Political Economy Vol. 86, No. 3 (Jun., 1978), pp. 485-503

20
Ibid.
21
Beales J.H., III, “Economic Analysis and the Regulation of Pharmaceutical Advertising”, 24 Seton Hall L.

Rev. 1370; See also Michael R.D., Karni E., “Free Competition and the Optimal Amount of Fraud”, 16 J.L. &

ECON. 67 (1973)
22
Ibid.
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Claims to be considered deceptive, do not necessarily have to be supplying false information.

Even omission of certain information can be considered to be deceptive to the consumers and
hence there are regulations which mandate a disclosure of the complete information
pertaining to a particular product.23

An example of such mandated disclosure is the warnings that are provided in packaging for
goods like cigarettes and other tobacco based products. Such a mandate is generally applied
across the board. There are also other disclosures which can be categorised as triggered
disclosures. Such disclosures need to be made only against a specific claim towards the
information.24

Though such regulations are very common in many legal systems, on further economic
analysis of the utility and efficacy of such regulations, the enforcement of such regulations
seems redundant.25 It has been suggested that as long as explicit deception is not allowed,
sellers have incentives to reveal negative attributes of their products.26

The hypothesis is that, if the negative attributes of a product are not revealed, the consumers
will rationally assume that an advertisement will omit a critical piece of information only if
the value of that attribute for that product is low. In such a situation the producers of products
with quality levels above the minimum will have incentives to advertise this fact, and
consequently the market will provide complete information.27 A very pertinent example in
this regard is the advertisement of cigarettes. In the 1950‟s due to rising awareness as regards
the detrimental effects of smoking on one‟s health, companies started advertising the tar and
nicotine content of the cigarettes. In this regard, the firms manufacturing cigarettes with the
lowest content of tar and nicotine had an incentive to advertise. Though this is not desirable
owing to non-economic considerations (regulation of advertisement is discussed in details in

23
Supra Note. 10
24
Ibid.
25
Ibid.
26
Ibid.
27
Ibid. ; See also Grossman S.J., “The Informational Role of Warranties and Private Disclosure about Product

Quality”, 24 J.L. & Econ. 461 1981

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the next section of the paper), it makes better economic sense to advertise the negative
attributes of a product.28

From the preceding discussion it can be inferred that regulations with regards advertisement
is relevant mostly in the case of credence goods. Regulation with regards price advertising
and other advertising pertaining to low priced experience products is unnecessary and to an
extent economically counterproductive. Mandated disclosures might be employed but with
the reservation of first observing the market and deciphering whether there exists a state of
equilibrium or disequilibrium, because in situations where the market is in transition from
disequilibrium to equilibrium, the characteristics of products change substantially in the long
run, and regulations might prove counterproductive.

Proceeding on the basis of the inferences drawn above, the next section analyses the
regulations in India with regards to advertisement and information disclosure.

IV. REGULATORY PROVISSIONS UNDER INDIAN LAW

For the purposes of this paper, three particular regulatory provisions shall be dealt with, viz.
regulation of advertisement of cigarettes and other tobacco products under the Cigarettes and
Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and
commerce and Production, Supply and Distribution) Act, 2003, regulation of advertisement
by attorneys under the Bar Council of India Standards of Professional Conduct and Etiquette
Rules, and lastly the regulations pertaining to telemarketing issued by the TRAI under the
Telecom Unsolicited Commercial Communications Regulations, 2007.

A. PROHIBITION OF ADVERTISMENT OF TOBACCO

The Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of
Trade and commerce and Production, Supply and Distribution) Act, 2003 explicitly prohibits
the advertisement (direct or indirect, indirect advertisement being in the nature of depiction

28
Ibid.; See also Teeter D.L., Loving B., “Law of Mass Communications: Freedom and Control of Print and

Broadcast Media” (Foundation Press, 10th Ed., 2001) at pp.753-773

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through the medium of films and cinema, etc.) It further mandates the inclusion of pictorial
warnings on the cigarette packs.29

The problem which arises regarding prohibition of advertisement of tobacco products is that
if the sale as well as the consumption of the ultimate product being advertised is not banned,
despite the fact that it may be extensively regulated, banning the advertisement of the same
severely restricts information transmission.

It may be argued that such regulations completely prohibiting the advertising are paternalistic
in nature.30 The justification for such a regulation is found not only from moral viewpoints,
but there also exist economic justifications. It might be argued that regulations such as this
are incorporated in order to reduce externalities. Any conduct which has an adverse effect on
an individual‟s health will give rise to medical care costs which might not necessarily be
borne by the individual himself, but by the tax payers (in the instance of publicly funded
health services such as the ones under the National health Service (NHS – UK)).31

But in the current case, the prohibition of advertisements cannot be justified primarily on the
ground that in the absence of a total ban on the consumption of tobacco, the externalities
caused by consumption of tobacco are not negated. Hence, the regulation on advertisement is
merely economically counterproductive in the sense, that it restricts information provided to
the consumers.32

B. PROHIBITION OF ADVERTISMENT OF SERVICES BY ATTORNEYS

29
Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and commerce

and Production, Supply and Distribution) Act, 2003; available at

203.193.146.66/hfw/PDF/Provisions_of_Tobacco_ControlActs.pdf last visited on 22/09/2010

30
Supra Note.1; See also Dworkin R., “Taking Rights Seriously” (Universal Publishers, 3rd Indian Reprint):

Paternalistic Regulations have been defined as the interference with a person‟s liberty of action justified by

reasons referring exclusively to the welfare, good, happiness, needs, interests or values of the person being

coerced.
31
Ibid.
32
See Discussion under Section III C above.
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Rule.36 of the Bar Council of India‟s (BCI), rules regarding the standards of professional
conduct and etiquette to be observed by advocates mandates that no advocate shall advertise
either directly or indirectly, any of his or her services.33

This rule prohibiting any kind of advertising by lawyers was challenged in the Supreme
Court. The Bar Council, which had earlier taken the view that unlike western countries where
lawyers were permitted to advertise their services, the same cannot be permitted in India as it
"cherished different ethos, social values and ethical norms," submitted its reply stating that it
had amended the Rule 36 by its resolution and that advocates can mention in their chosen
websites, their names, telephone numbers, e-mail ID, professional qualification and areas of
specialisation.34 However, such advertisements can be issued only within the parameters
fixed by it under the amended regulations, and any breach of the same would invite
disciplinary action.

Such prohibitions in advertisement have been categorised by economists and legal scholars
alike as a part of traditional attorney cartels.35 It is obvious from the observation of market
behaviour with regards advertisements, that in the absence or heavy restriction of
advertisement, the prices of the services would be higher as opposed to situations in which

33
Rule 36 “An advocate shall not solicit work or advertise, either directly or indirectly, whether by circulars,

advertisements, touts, personal communications, interviews not warranted by personal relations, furnishing or

inspiring newspaper comments or producing his photographs to be published in connection with cases in which

he has been engaged or concerned. His sign-board or name-plate should be of a reasonable size. The sign-

board or name-plate or stationery should not indicate that he is or has been President or Member of a Bar

Council or of any Association or that he has been associated with any person or organisation or with any

particular cause or matter or that he specialises in any particular type of work or that he has been a Judge or

an Advocate General.”
34
Lawyers can have their websites - BCI to Supreme Court, Economic Times, 28th July, 2008, available at

http://economictimes.indiatimes.com/News/PoliticsNation/Lawyers_can_advertise_on_Internet_BCI_tells_Supr

eme_Court/articleshow/3298619.cms last visited 22/09/2010

35
Supra Note. 10; See also Posner R., “The Material Basis of Jurisprudence”, 69 Ind. L.J. 1 (1993-1994)
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there are no regulations or restrictions on advertisement.36 Hence, bans on advertising of legal

services by attorneys, is consistent with their self interests.

C. TRAI REGULATIONS OF TELEMARKETING

The Telecom Regulatory Authority of India, by virtue of the Telecom Unsolicited

Commercial Communications Regulations, 2007 has established a National Do Not Call
Registry (“NDNC”), which contains a database of subscribers who do not want to receive
such calls. Telemarketers have to mandatorily register with the Department of
Telecommunications of the Ministry of Communication and Information Technology, in the
absence of which they would be liable to a disconnection of his telecom resources by the
service provider. A service provider also is prohibited from sending any unsolicited
commercial communication. The fine payable by a service provider for a call made to a
registered subscriber is Rs.5000 for the first call and Rs.20000 for every subsequent call.
Eventual observation led to the inference that these regulations were proving to be
ineffective. Hence, the TRAI established a „Call Receiver‟s Registry‟ whereby only those
who register will get commercial calls, and not others.37

The reasons for the failure of the NDNC construct might be the fact that the operative cost of
the medium being low, the telemarketers would not have had to bother about the transaction
costs incurred in dispensing the information, and despite the huge fine, a simple cost-benefit
analysis shows that the incentives of telemarketing were greater than compliance with the
regulatory rules.

36
See Discussion under Section III above. ; See also Cox S.R., Deserpa A.C., “Consumer Information and the

Pricing of Legal Services”, The Journal of Industrial Economics, Vol. 30, No. 3 (Mar., 1982), pp. 305-318

37
TRAI, Telecom Unsolicited Commercial Communication Regulations 2007; See also “Fines up to Rs 20,000

per pesky Tele call, rule TRAI”, Economic Times, 18 Mar, 2008, available at

http://economictimes.indiatimes.com/Telecom/Telcos_to_pay_Rs_520K_fine_for_every_unwanted_call/articles

how/2875603.cms last visited on 22/09/2010, “DND‟ Doesn‟t Work”, The Pioneer, 02 August, 2008, available

at http://www.dailypioneer.com/indexn12.asp?main_variable=EDITS&file_name=edit2.txt&counter_img=2 last

visited on 22/09/2010
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In the event that an unwilling consumer receives an unsolicited call, in order to avoid further
costs in reporting the call and believing that some other aggrieved consumer would
38
eventually report the particular telemarketer‟s act , he could choose to not report the call,
and hence most of the cases of unsolicited calls go unreported.

The second scheme of regulation suggested by the TRAI, is akin to a system of triggered
disclosures. What this does is effectively redefines the market, and reduces the costs incurred
by the telemarketers in identifying the consumers.

IV. CONCLUSION

A few very pertinent inferences might be drawn from the preceding discussion. Advertising
as a medium of conveying information helps in reducing transaction and information costs
for consumers. The sellers have incentives to advertise as economies of scale are involved
and, in a competitive market, advertising can help in differentiating their products. But in
pursuance of these incentives certain measures might be taken by the sellers which might
create undesirable consequences such as artificial product differentiation and subsequent
creation of a monopolistic situation of imperfect competition.

Intervention by the means of regulation of information might help in this regard. But on
analysis, regulations are effective only in very few cases. Regulations of advertisements are
most relevant in cases concerning credence goods. Regulation with regards price advertising
and other advertising pertaining to low priced experience products is unnecessary and to an
extent economically counterproductive.

Extending these results to analysing regulations existent under the Indian Legal System, it
can be concluded that total prohibition of advertisements is in the nature of a paternalistic
regulation and is economically counterproductive and the only justification for such a
regulation can be found in non-economic value systems dependent on morality, etc. Other
regulations try to balance various sets of interests. In the case of advertising legal services,
advertising is economically undesirable as it shall prevent the attainment of a low-cost
equilibrium in the market for legal services. In the case of telemarketing regulations, the costs
and benefits as to allocation of rights (Right to free speech and right to privacy) are balanced
in the most economically viable way.

38
This phenomenon is termed as the “free-rider” phenomenon or the “voters‟ dilemma” by political economists.
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Hence, Regulation of Advertisement in its scope of operation is economically beneficial only

in certain specific cases.