The macroeconomic relationship between advertising and consumption.

• Author: Jung, Chulho

1. Introduction

   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 aggregate consumption, arguing that advertising would not noticeably affect investment and government spending. Nevertheless, Ekelund and Gramm found no relationship between advertising and aggregate consumption.

   Taylor and Weiserbs [26] also examined the relationship between aggregate advertising and aggregate consumption.(1) This study is clearly in the minority; their results suggest that advertising affects aggregate consumption. In a book published the same year, Schmalensee [24], who was apparently unaware of the then-forthcoming Taylor and Weiserbs study, grappled with the problem of the aggregate advertising-aggregate consumption problem. His results conflict with those of Taylor and Weiserbs by failing to support the hypothesis that advertising affects consumption.

   In a still later article, Ashley, Granger, and Schmalensee [2] faulted the Taylor and Weiserbs study on four grounds: use of the Houthakker-Taylor framework,(2) use of the GNP deflator to deflate advertising expenditures, use of a two-stage least square model with an ad-hoc specification of the advertising equation, and use of annual data. With regard to the latter criticism, they cited Clarke [9] and Schmalensee [24; chap. 3], both of whom had found advertising effects to depreciate rapidly with most of the advertising effect depreciating within one year. This suggests that annual data may not contain much information about the direction of causation. The results of Ashley, Granger, and Schmalensee [2] suggest that consumption might affect advertising but that aggregate advertising does not seem to affect aggregate consumption. However, these results were called into question by Berndt [6] in his review.(3) He pointed out that, while Ashley, Granger, and Schmalensee obtained raw quarterly consumption data, the quarterly 'advertising data they used were seasonally adjusted. Berndt states "it is known that use of seasonally adjusted data can introduce bias into investigations of causality."

   Since the Ashley, Granger, and Schmalensee study, which considered the period 1957-75, little research has appeared in the economics literature concerning the aggregate advertising-aggregate consumption question. One study that comes close is Duffy [13], but he considers the effect of advertising on the distribution of demand across products.(4)

   A more closely-related study is Chowdhury [8], who considers the relationship among advertising and several macroeconomic variables using annual U.K. data over the period 1960-91. While his results support a relationship between advertising and unemployment, they do not support any other relationship including the one between advertising and consumption.

   In this paper, we explore the aggregate question using U.S. data and newer techniques than those used in most previous studies. While these techniques are similar to those used by Chowdhury [8] for his study of the U.K., there are some critical differences from our study, which we discuss in the conclusion.

2. Causal Directions between Advertising and Consumption

   In this study, we will perform causality tests between aggregate advertising and aggregate consumption. Before proceeding further with our analysis, we should clarify why one might believe that either one of these aggregates might affect the other.

   The hypothesized causal relationship from consumption to advertising is based on the observation that businesses tend to allocate a certain percentage of their (past) revenues to (future) advertising so that increased revenues, which accompany increased consumption, are associated with increased advertising. Some economists (e.g., Hay and Morris [20]) attribute this to satisfying behavior while others (e.g., Grabowski [17]) point out how it could reflect profit-maximizing behavior.

   The causal relationship from advertising to consumption is credited by Ekelund and Gramm [14] to Ackley [1] and Duesenberry [12]. Ekelund and Gramm credit both economists with observing that, if advertising does affect income as claimed by Hansen [19] (see footnote 1.), it would do so through consumption or, more specifically, through the marginal propensity to consume (MPC). Of course, an increase in the MPC would cause a decrease in the marginal propensity to save (MPS), so the effect of advertising is to increase current consumption at the expense of future consumption. Apart from the...