Question

How can we resolve the issue surrounding the desirability of product variety under monopolistic competition? What role does advertising play as a tool for firms in this regard? What would be a reasonable economic model of advertising?

Answer 1

Monopolistic competition is a market structure characterised by many firms selling products that are similar but not identical so that the firms compete on other factors besides price. The monopolistic competition is not as efficient as a perfect competition but has less deadweight loss than a monopolistic market. Here we have a large no of sellers with a lesser market share with a little interdependence among the firms.

                                             Monopolistic competition cannot exist unless there is a perceived difference among the products of the industries. The major tool of the competition is product differentiation, which results from differences in the product quality, location, service and advertising. Product quality can differ in function, design, materials and workmanship. Location is often a good differentiator of products. Generally, products more conveniently located can charge more prices. Service also forms a better method of product differentiation. For example, a medical store open for 24 hours attract more than one which opens for lesser hours of time. Restaurants serving different menu items at different places, furniture shops preferring different raw materials for producing same furnitures etc.. are examples for product differentiation in a monopolistic competitive economy. A new front of monopolistic competition occurs among the online retailers . In this case location doesnot matter. What matters is only the readiness to buying capacity, the reviews by buyers and the trustworthiness of the company. A primary feature of the monopolistic competitive market is the constantly changing array of products that are competing in the marketplace. Firms must continuously experiment with product, prices and advertising to see what yields the greatest profit.

IMPORTANCE OF ADVERTISING

                                             When there are only small differences between the products, product differentiation will not be useful unless it can be communicated with the customer. This communication is accomplished through advertising, brandnames and packaging which are forms of non-price competition, in that they compel the customers to pay a higher price- if they perceive rightly or wrongly that the quality is better. Advertising serves to inform the consumers of differentiated products and why they are superior over their close substitutes. Even if there are no differences, the consumer always prefers one over the other and advertising plays a major role in it just as one prefers the store drugs based on branding of medicines.

                                             Brandnames serves to distinguish identical or nearly identical products and to increase the value of advertising in that the bradname serves as the object to which desirable characteristics can be attached. Advertising may be also used to build a brand image, which is the association of lifestyle, words or images that the people will associate with the brand, rather than describing specific characteristics of the product itself. The bandwagon effect is often used, where the advertising tries to convey that more people prefer a particular brand. Celebrities are often used for this type of branding. The brandnames are well protected by the law and also they helps to readily identify a product. Advertising often helps a company in increasing its quantity of production which leads to decrease in the product price in the market. Advertising allows new firms to attract customers who are buying competing products, thus allowing easier entry of new firms. It also informs the customer of price differences so that they can buy at lower prices. Many times advertisements are misleading also. Many people pay more and many prefer brandname drugs over some generic drugs, although generic ones are better.