Explain why advertising is very important to a monopolistically competitive firm but not to a perfectly competitive firm or a monopolistic firm.
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The reason for this has to do with the sorts of goods that are sold in these various market structures. There is very little use for advertising in a monopoly and none in perfect competition.
In monopolistic competition, firms sell goods that are differentiated. What that means is that consumers can be convinced that there are real differences between the goods. These differences may be illusory or they may be real, but they are perceived as real by some consumers. It is very important for the firms to make the consumers feel those differences. They have to advertise so that consumers will feel that their product is different from and better than that of the competition.
By contrast, firms in a monopoly or in perfect competition are not selling differentiated goods. Firms in monopolies sell unique goods. They have no competition. Firms in perfect competition sell homogeneous goods. There is no difference between two firms’ goods and no way in which to convince consumers that there is a difference. In this market structure, advertising would simply be a waste of money.
Thus, the reason for the different role of advertising in these market structures stems from the different kinds of goods they sell.
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