Question

Consider ONE of the following industries: beer, cigarettes, movies. Discuss how advertising
and/or provision of information promotes or limits competition in the industry. What do you see
in terms of the prospects for long-term market power in the industry?

Answer 1

Above mentioned Industries are example of Monopolistic competition. We take example of Cigarettes. As under monopolistic competition there exist large number of firms with differentiated but similar products. In order to promote sales, any particular firm focus on non - price competition. It includes expenditure on advertisement and other selling cost. Advertisement and other promotion campagin of cigarette A would affect demand as well as its cost. Rival firm of cigarette B will keen to compete on same promotion ground.

Main purpose will be to inform customers about firms' product and to attract more customer. In short run, some new customers may buy new product , Some may choose substitute , Some will remain loyal as regular one.

In long run, as per Chamberlin and stigler there will be symmetry assumption. All firms will behave as perfect market competition with normal profits but its price is higher and output will be smaller.  

As in perfect competition , equilibrium is established at minimum average cost curve. But In , monopolistic Industry operates at point at which average cost is falling to order to keep prices higher than under perfect competition. There will be left unused capacity called excess capacity.

In figure, monopolistic Industry will produce OQ quantity instead of OQ1. Prices will be charged OP instead of OP1. QQ1 is excess capacity.