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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Perfect competition arises from the equilibrium state of supply and demand. A firm in perfect competition is selling the same undifferentiated product as other firms, and their demand is directly based on market equilibrium factors. Because of this, there is no need for marketing, because the business will exist and...

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Perfect competition arises from the equilibrium state of supply and demand. A firm in perfect competition is selling the same undifferentiated product as other firms, and their demand is directly based on market equilibrium factors. Because of this, there is no need for marketing, because the business will exist and the demand will continue as long as the market dictates it.

For monopolistic competition, everyone is trying to gain market share, and all firms have differentiated products. Because of this, firms have to advertise their particular strengths to drive more traffic to their business. For instance, a fast food restaurant will advertise their expansive breakfast menu to capitalize on those customers who desire breakfast food quick, as opposed to another firm exclusively advertising their low prices. A firm in monopolistic competition will have to sell its benefits in order to increase demand for its product.

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There are three types of firms listed here, and they're all different, so let's analyze them because that will clarify why advertising is important.

A perfectly competitive firm exists in a world where competition is dictating all the business actions and consumer demands. In this world, a consumer will naturally gravitate towards the firm with the best offering of products they need for the price they can afford. Therefore, advertising is unnecessary.

A monopolistic firm is the exact opposite—they control the entirety of the type of good they are selling. In that situation, there is also no need for advertising, because all the demand will go through them, since they own that entire product.

So, a firm in monopolistic competition is one that holds a competitive advantage over other firms in one regard but still must maintain a market share. To do this, they advertise and attempt to drive business to their company.

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In a monopolistic competition, advertising is very important to the firm because it helps the company maintain its profits and prevents competitors from stealing its market share. A monopolistic competitive firm has the characteristics of both a monopolistic and a perfectly competitive firm. For example, there is freedom of entry and exit in both a monopolistic competitive firm and a perfectly competitive firm. However, advertising cannot work well in a perfectly competitive market, because the competing firms sell similar goods. The lack of product differentiation means that the marketing campaign won't have an effect on buyer behavior. Alternatively, firms are price makers in both a monopoly and monopolistic competition. However, a monopoly doesn't need to advertise, because it doesn't have any competitors. Since there are barriers to entry in a monopoly market, there is only one firm that can manage to overcome such obstacles.

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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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