“Regulating Misinformation,” E. Glaeser & G. Ujhelyi (2010)

Consumers are often, as Larry Summers famously said, idiots. Consider a market where consumers do not know their true ex-post utility; for instance, they may be misinformed about the effectiveness of some medicine. Assume that firms can affect that misinformation by advertising. Naively, it seems reasonable that government should ban such advertising. However, under imperfect competition, consumption is lower than optimal. Therefore, there is a positive level of misinformation which can improve welfare by increasing consumption! When misinformation is too high, however, government can act by taxing advertising, taxing sales or by counter-advertising. In the simplest model, taxing advertising alone is optimal. However, when firms can invest in quality improvements as well as advertise, there is a complementarity between the two (higher quality increases demand, which increases the gains from misinformation). In that case, it can be optimal for the government to both counteradvertise and to tax advertising.

The results in this paper are related to Mullainathan et al (2008) and Gabaix & Laibson (2006).

http://pcsi.pa.go.kr/files/w12784.pdf (link to NBER WP; final version in JPubE 94)

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