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• In perfect competition, P = MC.
  • Advertisement increases MC and for some firms, there might be no scope for advertisement (increasing MC)
  • also, because homogeneous products.
• In imperfect competition, P > MC and there could be product differentiation
  • again if homogeneous products, no scope for ads
• Advertisement can increase product differentiation.
  • Difficult to say if, advertisement leads to product diff or vice versa
• can’t decide if ads are good or bad for society
  • Bad:
    • socially wasted
    • manipulative
    • hinders competition as leads to higher product differentiation
  • Good:
    • innovative
    • gives rise to competition
      • it is good for society

How much ad to do?

Assume

• price P,
• marginal cost MC at this level
• ad spent ₹1

Gain from selling one more unit because of ad = P-MC

Gain from selling quantity q because of ad = $\Delta$Q(P-MC)

• If gain is more than 1, increase the ad.
• If gain is less than 1, increase the ad.
• If gain is equal to 1, optimal level.

Gross Gain (multiplying both sides by P)

$$ P \Delta Q = \frac{P}{P-MC} \\ P \Delta Q = \frac{1}{1-\frac{MC}{P}} = |\epsilon| $$

Increase ad if $P \Delta Q > |\epsilon|$ (elasticity)

The correct decision is to increase advertising until the marginal revenue from an additional dollar of advertising, MR(Ads), just equals the full marginal cost of that advertising. That full marginal cost is the sum of the dollar spent directly on the advertising and the marginal production cost resulting from the increased sales that advertising brings about. Thus the firm should advertise up to the point that