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Chapter 17: Q6. (page 672)

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

Expert verified

The truth in advertising helps promote competition by providing consumers information that is necessary for them to make optimal decisions.

If the firm advertises deceptively, then consumers will not be able to compare the goods and will get stick to one good, making it less competitive.

Step by step solution

01

Truth in marketing provides the necessary information to the customer

When firms advertise truthfully, it enables the customer to gather the necessary information to make optimal decisions.In the absence of a true advertisement, a consumer will not know the true picture of the market, creating a problem of asymmetric information and causing the market to fail.

02

Deceptive advertisements results in consumer sticking to one good

Deceptive advertisements convey wrongful information to consumers. This results in a lack of awareness about the quality of the different products or misleading purchases of bad quality products. Eventually, the customers lose trust and stick to the product they are used to buying and find satisfying. This reduces the competition in the market.

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Most popular questions from this chapter

An insurance company is considering issuing three types of fire insurance policies: (i) complete insurance coverage,(ii) complete coverage above and beyond a $10,000 deductible,

and (iii) 90 percent coverage of all losses. Which policy is more likely to create moral hazard problems?

UNIVERSAL SAVINGS & LOAN has \(1000 to lend. Risk-free loans will be paid back in full next year with4% interest. Risky loans have a 20% chance of defaulting(paying back nothing) and an 80% chance of paying back in full with 30% interest.

a. How much profit can the lending institution expect to earn? Show that the expected profits are the same whether the lending institution makes risky or risk-free loans.

b. Now suppose that the lending institution knows that the government will “bail out” UNIVERSAL if there is a default (paying back the original \)1000). What type of loans will the lending institution choose to make? What is the expected cost to the government?

c. Suppose that the lending institution doesn’t know for sure that there will be a bailout, but one will occur with probability P. For what values of Pwill the lending institution make risky loans?

You have seen how asymmetric information can reduce the average quality of products sold in a market, as low-quality products drive out high-quality products. For those markets in which asymmetric information is prevalent, would you agree or disagree with

each of the following? Explain briefly:

a. The government should subsidize ConsumerReports.

b. The government should impose quality standards—e.g., firms should not be allowed to sell low-quality items.

c. The producer of a high-quality good will probably want to offer an extensive warranty.

d. The government should require all firms to offer extensive warranties.

Professor Jones has just been hired by the economics department at a major university. The president of the board of regents has stated that the university is committed

to providing top-quality education for undergraduates. Two months into the semester, Jones fails to show up for his classes. It seems he is devoting all his time to research rather than to teaching. Jones argues that his research will bring prestige to the department and the university. Should he be allowed to continue exclusively with research? Discuss with reference to the principal–agent problem.

A firm’s short-run revenue is given by R= 10e- e2, where eis the level of effort by a typical worker(all workers are assumed to be identical). A worker chooses his level of effort to maximize wage less effortw- e(the per-unit cost of effort is assumed to be1). Determine the level of effort and the level of profit(revenue less wage paid) for each of the following wage arrangements. Explain why these different principal-agent relationships generate different outcomes.

a. w= 2 for; otherwise, w= 0.

b. w= R/2.

c. w= R- 12.5.
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