The product-variety externality: Because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers. o The business-stealing externality: Because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms. In the end, we can conclude only that monopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive markets. That is, the invisible hand does not ensure that total surplus is maximized under monopolistic competition. Yet because the inefficiencies are subtle, hard to measure, and hard to fix, there is no easy way for public policy to improve the market outcome. ADVERTISING Such behavior is a natural feature of monopolistic competition (as well as some oligopolistic industries). When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise to attract more buyers to its particular product. For the economy as a whole, about 2 percent of total firm revenue is spent on advertising. The Debate Over Advertising Assessing the social value of advertising is difficult and often generates heated argument among economists. The Critique of Advertising : o Critics of advertising argue that firms advertise to manipulate people's tastes. Much advertising is psychological rather than informational. Consider, for example, the typical television commercial for
some brand of soft drink. The commercial most likely does not tell the viewer about the product's price or quality. Instead, it might show a group of happy people at a party on a beach on a beautiful sunny day. In their hands are cans of the soft drink. The goal of the commercial is to convey a subconscious (if not subtle) message: “You too can have many friends and be happy, if only you drink our product.” Critics of advertising argue that such a commercial creates a desire that otherwise might not exist. o Critics also argue that advertising impedes competition. Advertising often tries to convince consumers that products are more different than they truly are. By increasing the perception of product differentiation and fostering brand loyalty, advertising makes buyers less concerned with price differences among similar goods. With a less elastic demand curve, each firm charges a larger markup over marginal cost. The Defense of Advertising : o Defenders of advertising argue that firms use advertising to provide information to customers. Advertising conveys the prices of the goods offered for sale, the existence of new products, and the locations of retail outlets. This information allows customers to make better choices about what to buy and, thus, enhances the ability of markets to allocate resources efficiently.
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