Which of the following statements about expenditures on advertising is true?

Which of the following statements about expenditures on advertising is true?

A. When a firm spends a small amount of money on advertising, this signals that the quality of the good is high.

B. If a firm knows its product is of low quality, it will be willing to spend large amounts of money on advertising.

C. When a firm spends a large amount of money on advertising, advertising can be construed as a signal of quality.

Answer. C. When a firm spends a large amount of money on advertising, advertising can be construed as a signal of quality.

Here, the cost of advertising can be viewed as a signal within the framework of the information economics approach. It is an indication that a firm has strong believe in the product’s market since it has invested a lot in advertising. The rationale here is that a company wouldn’t invest large amounts of money in a product which it expected to be of poor quality since the money will not be recouped. Therefore, it could be concluded that it is credible when firms use a large amount of money in advertising, especially for the products that do not possess strong quality indicators on their own. This theory that goes by the name “advertising as a signal” posits that since the amount of advertising provides the consumer with information they are able to use in evaluating the quality of a firm’s product, then this information should be credible.