Question

To promote competition and consumer welfare, the Federal Trade Commission requires firms to advertise truthfully. How does truth in advertising promote competition? Why would a market be less competitive if firms advertised deceptively?

Short answer

Truth in advertising promotes competition by leveling the playing field, encouraging firms to innovate, improve product quality and maintain fair pricing. Deceptive advertising, on the other hand, disrupts these competition dynamics by creating market inefficiencies, undermining consumer trust and discouraging fair competition.

Step-by-step solution

Understanding the Role of Advertising

Advertising is a significant tool for businesses to communicate with potential customers about their products or services. In a competitive market, it helps distribute information about differences between competing products, which, in turn, allows consumers to make informed buying decisions.

Impact of Truthful Advertising

When firms advertise truthfully, they provide accurate and reliable information about their products or services. This increases the consumers' trust in the products, encourages competition as businesses strive to improve their offerings, resulting in increased consumer welfare due to better products and services or competitive prices. Thus, a transparent information flow is essential for the health of a competitive market.

The Consequences of Deceptive Advertising

If firms advertised deceptively, they would be providing false or misleading information about their products or services. This could lead consumers to make suboptimal purchasing decisions, creating a market inefficiency. Additionally, it would introduce an unfair advantage for the deceiving firm, undermining competition as competitors may lose customers due to the deceptive advertisements. Hence, a market saturated with deceptive advertising is likely to be less competitive.