6. Why is there so much advertising in monopolistic competition and oligopoly? H
ID: 1115208 • Letter: 6
Question
6. Why is there so much advertising in monopolistic competition and oligopoly? How does such advertising help consumers and promote efficiency? Why might it be excessive at times? LO4 7. ADVANCED ANALYSIS Construct a game-theory matrix involving two firms and their decisions on high versus low advertising budgets and the effects of each on profits. Show a circumstance in which both firms select high advertising budgets even though both would be more profitable with low advertising budgets. Why won't they unilaterally cut their advertising budgets? LO4Explanation / Answer
Answer) Monopolistic competition and Oligopoly are types of imperfect competition. These type of competition is characterised as -
Product development and advertising are two important ways in which firms maintain economic profits. Advertising will increase the demand for firm's products and this will increase the sales and as a result profits will increase. Same way, in oligopoly, firms will increase their profits by financing their advertisement costs. Advertising benefits consumers as well. It provides a source of information about the variety of products in the market to the consumers. Advertising will help firms achieve the efficiency point of minimum ATC by increasing output of firms. Lowering of Average total cost curve will increase the efficiency of firms in the long-run. However, excessive advertising should be avoided as it leads to barrier to entry of new firms thus, giving monopoly power to the firms. This situation will no longer be beneficial to consumers and it will be inefficient.
Answer 2
Firm A's Advertising
Firm B's Advertising
In the above payoff matrix given, each firm A and B can choose between a high budget or low budget advertising costs. For example, Firm A chooses high budget so it will earn profit $ 120 and if Firm B chooses low budget then it will earn profit of $ 60. Hence, the payoff matrix suggests that both firms should have high advertising budgets. But, if they do so they will have reduced profits . So, it is a worse off situation than if they both have low advertising budgets in which they will not loose profits but this cannot be done unless the rival firms collude.
Low Budget High Budget Low Budget $100/ $100 $120/ $60 High Budget $60 / $120 $80 / $80Related Questions
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