Read this chapter to learn about monopolistic competition. Make sure to distinguish the short-run from the long-run model.
Advertising and branding help firms in monopolistic competitive markets differentiate their products from those of their competitors.
Evaluate whether advertising is beneficial or detrimental to consumers
One of the characteristics of a monopolistic competitive market is that each firm must differentiate its products. Two ways to do this is through advertising and cultivating a brand. Advertising is a form of communication meant to inform, educate, and influence potential customers about products and services. Advertising is generally used by businesses to cultivate a brand. A brand is a company's reputation in relation to products or services sold under a specific name or logo.
Listerine advertisement, 1932: From 1921 until the mid-1970s, Listerine was also marketed as preventive and a remedy for colds and sore throats. In 1976, the Federal Trade Commission ruled that these claims were misleading, and that Listerine had "no efficacy" at either preventing or alleviating the symptoms of sore throats and colds. Warner-Lambert was ordered to stop making the claims and to include in the next $10.2 million dollars of Listerine ads specific mention that "contrary to prior advertising, Listerine will not help prevent colds or sore throats or lessen their severity".
The purpose of the brand is to generate an immediate positive reaction from consumers when they see a product or service being sold under a certain name in order to increase sales. A brand and the associated reputation are built on advertising and consumers' past experiences with the products associated with that brand.
Reputation among consumers is important to a monopolistically competitive firm because it is arguably the best way to differentiate itself from its competitors. However, for that reputation to be maintained, the firm must ensure that the products associated with the brand name are of the highest quality. This standard of quality must be maintained at all times because it only takes one bad experience to ruin the value of the brand for a segment of consumers. Brands and advertising can thus help guarantee quality products for consumers and society at large.
Advertising is also valuable to society because it helps inform consumers. Markets work best when consumers are well informed, and advertising provides that information. Advertising and brands can help minimize the costs of choosing between different products because of consumers' familiarity with the firms and their quality.
Finally, advertising allows new firms to enter into a market. Consumers might be hesitant to purchase products with which they are unfamiliar. Advertising can educate and inform those consumers, making them comfortable enough to give those products a try.
There are some concerns about how advertising can harm consumers and society as well. Some believe that advertising and branding induces customers to spend more on products because of the name associated with them rather than because of rational factors. Further, there is no guarantee that advertisements accurately describe products; they can mislead consumers. Finally, advertising can have negative societal effects such as the perpetuation of negative stereotypes or the nuisance of "spam".