Regulating Deceptive Advertising: False Claims and Skeptical Consumers
Yue Wu and Tansev Geylani (2019)
In today's business world, firms often claim that their products are superior, but product statements may not be truthful. Knowing firms' potential dishonesty, consumers are skeptical about these possibly false statements and may verify them. To protect consumers, regulators can penalize firms who deceive consumers. In response to consumers and regulators, firms have incentives to make their false claims deceptive, so that others find it hard to verify. In this paper, we develop a game theoretical model to study the interaction between dishonest firms, skeptical consumers, and regulations. We show that increasing the penalty for false statements can surprisingly reduce consumer surplus, firm profits, and social welfare. The reduction in welfare is because raising the penalty can incentivize higher spending on deceptiveness, which hinders consumers from investigating potentially false claims. The lack of information makes it difficult for consumers to identify product quality, thus leading to lower welfare. Furthermore, when it is costless for regulators to adjust the penalty, we find the optimal penalty that maximizes both consumer surplus and welfare. This optimal penalty is the minimum penalty that ensures truthful claims, and it increases with firms' quality difference and the probability that consumers encounter a high-quality firm.