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The Cyclical Response of Advertising Refutes Counter-Cyclical Profit Margins in Favor of Product-Market Frictions

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  • Robert E. Hall

Abstract

According to the standard model, advertising is remarkably sensitive to profit margins. Firms advertise to stimulate demand for their products. They advertise high-margin products aggressively and low-margin ones hardly at all. In macroeconomics, variations in profit margins over the business cycle have a key role. A widening of margins can explain the rise in unemployment in recessions. A higher margin implies a lower real wage. A variety of models ranging from Keynesian to search-and-matching map a decline in wages to higher unemployment. But a rise in profit margins should expand advertising by a lot. Really a lot. Advertising should be highly countercyclical. Instead, it is somewhat procyclical. The ratio of advertising spending to private GDP falls when the economy contracts. The behavior of advertising refutes the hypothesis that profit margins rise. But it is true that the labor share of income falls. Hence there must be another factor that lowers the labor share without raising profit margins. The only influence that fits the facts is a rise in a product-market friction that has the same effect as an increase in sales taxes.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18370.

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Date of creation: Sep 2012
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Handle: RePEc:nbr:nberwo:18370

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  1. Armstrong, Mark & Porter, Robert, 2007. "Preface to the Handbook of Industrial Organization, Volume 3," Handbook of Industrial Organization, Elsevier.
  2. Bils, Mark, 1987. "The Cyclical Behavior of Marginal Cost and Price," American Economic Review, American Economic Association, vol. 77(5), pages 838-55, December.
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  6. Christopher J. Nekarda & Valerie A. Ramey, 2013. "The Cyclical Behavior of the Price-Cost Markup," NBER Working Papers 19099, National Bureau of Economic Research, Inc.
  7. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
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Cited by:
  1. Nicolas Petrovsky-Nadeau & Etienne Wasmer, 2011. "Macroeconomic Dynamics in a Model of Goods, Labor and Credit Market Frictions," Sciences Po publications info:hdl:2441/5l6uh8ogmqi, Sciences Po.
  2. Loukas Karabarbounis, 2013. "The Labor Wedge: MRS vs. MPN," NBER Working Papers 19015, National Bureau of Economic Research, Inc.

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