i have been reading about perfect competition. where a firm produces at mc=mb, and also the demand curve. is there an example of firms like this in the real world? or is it hypothetical? another question I have is: why does demand become more elastice when a firm advertizes? it seems to me it should become more inelastic. can anyone explain?
First Question Firms in this category are the ones who sell generic brands. Farmers fall in this category Second Question I’m not sure but I think that demand becomes more elastic with advertising because companies give consumers a reason to buy their products and so when they cut their prices or convince consumers that their prices match the perceived quality of their products (product differentiation), a little price cut might increase the quantity demanded by more than the percentage price decrease. Producers except the demand for their products to become more elastic with advertising so that they can actually influence the purchase decisions of buyers. I hope this is correct. Please someone jump in!
In monopolistic competition, there is very small difference between the product that firms produce. So individual firm spends money on advertising to educate consumers about their products. In monopolistic competition for example, due to availability of alternatives the demand curve is inherently elastic and this causes individual firms to spend money on advertising. So I think it is elasticity of demand curve that results in higher advertising costs and not other way around.
Yes…in a perfect competition there are NO barriers to entry, thus, anyones neighbor can become a wheat farmer. I can become a wheat farmer by planting wheat on my apartment terrace. Thus, market price = marginal revenue. This also implies that you can keep increading your production until your margical cost = marginal revenue, so you are efficiently producing. I like kguizo’s response to the elasticity of demand. Remember ‘elasticity’ is like a rubber band (cheeze example i know) so that means the more advertising the more reach you are getting out to consumers which implies that there will be more of a reaction to your advertising. Just like price elasticity…when price of a unit goes up demand becomes elastic by going down…if a unit is very elastic (brand toothpaste) it requires constant advertising (use Colgate or Crest) because they depend on every little bit of purchase. I hope that makes sense??
If I understand correctly: When companies in a monopolistic competition environment adverstise, demand for a specific company’s product becomes more elastic because people could buy that company’s product or just another company’s product which seems to be as good or better (according to their ads). For example, you want to buy a Calvin Klein sweater (which usually puts their ads in magazines) that is selling for $60, but you see a Tommy Hilfigher (which regularly advertises in magazines too) sweater on sale for $50, you would tend to go buy that Tommy Hilfigher sweater because you came previously came accross TH’s ads and think that it is a good brand. I think that’s what it is… please correct me if I’m wrong.
1st question: Always MB=D; In perfect Competition the MR curve will be perfectly elastic. In perfect competition Consumers and producers will buy where supply=demand at the MR line. To be efficient MR=MC and in perfect competition the price will be set where supply=demand and producer will be able to sell as much or as little as he wants at the MR line. In the real world think about a farmer. There are many producers and it is very difficult to differentiate themselves from the competition so they have to take the open market price that is where the MR line will be set. Where supply meets demand. IE. Price Takers. 2nd question: When you advertise you tell the customer more about yourself. Whether it be quality or price. Mainly you are arming the customer with more information on price making your product now more price sensitive, because now they have easy access to your price and possibly quality as compared to your competitiors. Now a consumer has the ability to notice changes in the product, generally speaking the price to buy the good. Hope that makes sense.
BTW, I was just going through the advertising part yesterday in my studies. It’s under the ‘monopolistic competition and oligopoly’ chapter of the economics book.