Ads Are a Positional Good

Non-technical armchair economics post, where I explain my pet theory for why everything on and outside of the internet is absolutely infested with ads.

The traditional explanation is that any paid service will lose out to a “free” service funded by advertising. I think there’s some truth to it! Another explanation is transaction overhead. You basically can’t pay 1 cent for something, as just the annoyance of using the debit card is greater than the value. Contrast with the ease of dismissing a cookie consent banner! I think this is also important, but, at best, a part of the story.

The simple fact is that even paying for things doesn’t rid you of those pesky attention vampires! When I go to the cinema, I buy the ticket, but still have to sit through ten minutes of advertisement. Similarly, I pay for subscription to economist.com, and I still see a lot of ads if I disable my ad-blocker.

I think there’s a more fundamental force in play here, which is, you guessed it: ads are a positional good. Let me unpack!

Positional Good is a term from economics. To explain it, let’s start with a normal good, like bread. You want bread because you derive value from it, you avoid starvation. So you are willing to buy it, and the price you are willing to pay is proportional to the value you personally derive from it. In general, you want to pay only so much for bread, because your hunger is finite.

In contrast, the value of a positional good is indirect. It is how much less of the good the others have. What matters is not the absolute amount of good you have, but your relative position among other actors. A standard (though somewhat muddled) example is a University degree. There’s certain intrinsic value in having a degree from a more prestigious University, even if we keep the actual level of knowledge attained fixed. “Better” degree positions you higher relative to other job applicants. So prospective students compete for a limited number of seats not so much with the underlying hard granite of science, but rather with each other, and only the brightest go to the best University (which creates a feedback loop, but this is the other mechanism, not covered by the article).

I think it is the same for ads! If you are in a supermarket and want to buy a soft drink, you decision (simplifying, of course!) is based on how much craving you have and how much do you value your craving in euros. If you are particularly thirsty, you might even buy a larger bottle, but unlikely more than one.

Now imagine that you are a soft drink company, and you are considering an ad slot before a movie. How much should you pay? Well, it’s easy — just a little bit more than your rival company! Your ads aren’t going to meaningfully affect the amount of thirst people have, but they certainly can nudge the decision of which soft drink to buy. And, given that the other company is locked into the same logic, you are going to spend basically as much as you can afford.

And that is my mental model. While advertising creates some value directly, by informing customers of their options, I think that the bulk of ads is pure competitive value destruction, which redirects surplus value created by productive economic activity to companies hosting advertisement battlegrounds, with human attention being merely a collateral damage.