Question

In monopolistic competition and oligopoly:

what the relationship between advertising costs and increased sales would result in higher profits?

what the relationship between advertising costs and increased sales would result in lower profits?

Answer 1

In monopolistic competition and oligopoly the demand curve is downward sloping. this gives the market power to the firms operating in this market so that they can charger price greater than the marginal cost. Advertising helps in increasing the demand and therefore increasing the power of charging a price greater than the marginal cost.

When advertising is done there are two effects, the price that the firm can charge is increased and there is an increase in the sales. On the other side there is an increase in the total caused due to the cost of advertising which shifts the marginal cost and average total cost curves up.

In this manner advertising cost is borne by the firm as long as the increased revenues from sales due to increased advertising outweighs the advertising cost.

Profits will be lower for monopolistically competitive firms because they are demand is highly elastic an advertising is it uses the elasticity by a smaller value. In contrast profits are larger for oligopoly firms because their demand is relatively inelastic due to the presence of only few firms.