RATIONALES FOR PUBLIC INTERVENTION

Are cigarette smokers well-informed about the risks of smoking so they can make rational choices? Some economists (Lundborg and Lindgren, 2004; Viscusi, 1995) have challenged the common wisdom that smokers are illinformed, reporting smokers’ knowledge and responses to risk to be similar to that of nonsmokers. Despite this, findings from various fields regarding smoker and nonsmoker behavior more often suggest that smokers differ from nonsmokers on these bases. Consider nonsmokers first. We mentioned that another justification for intervention is that smoking has detrimental side effects on others, or “external costs.” Much then depends on the size of these costs. These externalities come from two principal sources: the passive smoking incurred by people nearby, and various other external costs caused by health hazards to the smoker. Manning et al. (1991) estimated the external costs at the equivalent of $0.33 per pack for a new smoker evaluated in 1995 dollars, though he did not examine passive smoking costs. Viscusi (1995) also estimated the external costs per pack to be in this range, though lower than Manning’s, and near zero under some scenarios. Because economic efficiency is only one economic criterion (the other is equity), because experts may dispute data issues, and because economics is not the only basis to consider, many choose to intervene in tobacco and alcohol use. Economics offers two major tools that may be effective in curbing consumption of a targeted bad: restrictions on advertising and imposition of excise taxes. Advertising can be restricted by tax code revisions, but most often the public issue is whether to restrict advertising by selective or total bans. The excise tax tool is theoretically effective to the degree that demand is more elastic for a given supply. These two principal tools of intervention form the subject of our next investigations. First, however, consider why we have chosen not to address the several other tools.

Other Interventions
Two other potential forms of intervention are prohibitions on the consumption of the product and penalties for consumption or misuse of the product. Outright prohibition of cigarettes is unlikely to occur in the United States. Accounts of 1920s Prohibition in the United States seem to point to that clear conclusion. Furthermore, alcohol prohibition of that era probably was not even effective in reducing alcohol consumption (Miron, 1999; Dills, Jacobson, and Miron, 2005). Lesser prohibitions, however, often have been accepted and proven effective. These include the effect of lower speed limits on rates of fatal accidents involving alcohol, as well as bans on smoking in public places.3 Many countries, especially in Scandinavia, apply much more severe penalties for drunk driving than does the United States. These include stiff jail sentences for alcohol offenses, offenses that many Americans regard as less serious. Mullahy and Sindelar (1994) showed for U.S. data that legal penalties affect drunken-driving behavior. Increased fines and license revocations significantly reduce the individual’s probability to drive drunk. Regulation of smoking sometimes fails to work, although some research has found reductions in smoking after the passage of clean air restrictions. Tax effects might even be somewhat overestimated if part of the “tax effect” is really due to unmeasured local clean air restrictions. However, a recent Canadian study provides an example of research that finds regulation to be relatively ineffective (Lanoie and Leclair, 1998).

ADVERTISING RESTRICTIONS ON CIGARETTES AND ALCOHOL
We begin with the role of advertising on cigarettes. At issue is whether advertising can increase the total consumption of bads like cigarettes. The issues we will address are ones on which people differ and hold strong views. In a report on cigarettes, the surgeon general (1989) concluded at one point that: There is no scientifically rigorous study available to the public that provides a definitive answer to the basic question of whether advertising and promotion affect the level of tobacco consumption. Given the complexity of the issue, none is likely to be forthcoming in the foreseeable future. (pp. 516–517) Even this conclusion was disputed by parties to both sides of the issue. Economists understand that well-intentioned interventions often have unintended consequences. Before blaming advertising for our ills, we should inquire into its nature.

THEORIES OF ADVERTISING Three main theories explain how advertising works and what it does for or to the community. Advertising alternatively is a form of information, a tool for persuasion, or a complementary good. The first two of these represent an old battle in advertising theory with contrasting villains and heroes: Information is generally beneficial, while persuasion is at least more questionable. The most recent addition treats advertising as a complementary good. Finally, Box 24-2 visits the advertisement of worthless goods—patent medicines.

ADVERTISING AS INFORMATION Nelson (1970, 1974) studied the implications of advertising as information. Viewed as information, advertising lowers equilibrium prices, creates better access to the market for new entrants, and provides better matches of consumer preferences with feasible consumption bundles. Informed consumers find that their dependence on or loyalty to Brand A will be weakened by their improved knowledge of alternatives. If consumers find it easy to opt for another brand, then they have flexibility, and flexible consumers will more likely resist undesirable changes

in the brand, such as a drop in quality or an increase in price. This greater responsiveness to price implies a more elastic demand, and it makes possible lower market equilibrium prices. How can the firm’s costly advertising activity help but be passed on to consumers in the form of higher prices? The mistake is that while the price at a given output must rise, the market equilibrium quantity may change due to competition, and the equilibrium price may fall.

ADVERTISING AS A BARRIER TO ENTRY In contrast to advertising as information, Bain (1956) argued that advertising differentiates one brand from another, creating increased brand loyalty. By making consumers more resistant to price changes and demand, advertising can result in greater market power and higher equilibrium prices. Comanor and Wilson (1974) added that the persuasive power of advertising may make it asymmetrically effective for the incumbent versus potential new entrants. Consumers have greater experience with established firms and greater recognition of them. The next advertising dollar spent by the established firm will yield a greater return than the same dollar spent by the newcomer.

ADVERTISING AS A COMPLEMENTARY GOOD Nobel laureate Gary Becker and colleague Kevin Murphy (1993) proposed a theory to account for these competing claims within a single model— one that appeals to an older theory of complements and substitutes. Let advertising be considered a good that is a complement to the good advertised. A consumer might wade through commercials with irritation during a ball game but enjoy the humorous one featuring a favorite beer. The commercial increases the consumer’s marginal utility from consuming that brand and, under this theory, firm advertising will raise total consumption of the product, just as a reduction in the price of mustard will increase the consumption of hot dogs