How does advertising impact monopolistic competition?

 

The U.S. economy spent about $139.5 billion on advertising in 2012, according to Kantar Media Reports. Roughly one third of this was television advertising, and another third was divided roughly equally between Internet, newspapers, and radio. The remaining third was divided up between direct mail, magazines, telephone directory yellow pages, billboards, and other miscellaneous sources. More than 500,000 workers held jobs in the advertising industry.

Advertising is all about explaining to people, or making people believe, that the products of one firm are differentiated from the products of another firm. In the framework of monopolistic competition, there are two ways to conceive of how advertising works: either advertising causes a firm’s perceived demand curve to become more inelastic (that is, it causes the perceived demand curve to become steeper); or advertising causes demand for the firm’s product to increase (that is, it causes the firm’s perceived demand curve to shift to the right). In either case, a successful advertising campaign may allow a firm to sell either a greater quantity or to charge a higher price, or both, and thus increase its profits.

However, economists and business owners have also long suspected that much of the advertising may only offset other advertising. Economist A. C. Pigou wrote the following back in 1920 in his book, The Economics of Welfare:

It may happen that expenditures on advertisement made by competing monopolists [that is, what we now call monopolistic competitors] will simply neutralise one another, and leave the industrial position exactly as it would have been if neither had expended anything. For, clearly, if each of two rivals makes equal efforts to attract the favour of the public away from the other, the total result is the same as it would have been if neither had made any effort at all.
Watch this video about the success Axe bodyspray has seen through its advertising campaign:


Self Check: Advertising
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