Style Over Substance? Advertising, Innovation, and Endogenous Market Structure

Abstract

While firms use both innovation and advertising to boost profits, markups, and market shares, their broader social implications vary substantially. We study their interaction and analyze their implications for competition, industry dynamics, growth, and welfare. We develop an oligopolistic general-equilibrium growth model with firm heterogeneity. Market structure is endogenous, and firms' production, innovation, and advertising decisions interact strategically. We find advertising reduces static misallocation, but also depresses growth through a substitution effect with R\&D. Although advertising is found to be socially useful, taxing it could simultaneously increase dynamic efficiency, contain excessive advertising spending, and raise revenue, while still reducing misallocation.

Keywords: innovation, advertising, markups, growth, industry dynamics, misallocation, business dynamism

JEL Classification: E20, M30, O30, O40