A.Innovation and Product Development
A firm in monopolistic competition will continuously develop new products so that it can continue to earn an economic profit. If the firm does not innovate, new firms will enter the market and capture the existing firm’s economic profit.
- Cost Versus Benefit of Product Innovation
To decide the degree to which it will innovate, a firm compares the marginal cost of innovation to the marginal benefit of innovation.
- Efficiency and Product Innovation
On one hand, product innovation brings to market many improved products that have great benefits to consumers. On the other hand, many so-called improvements amount to little more than packaging changes.
A firm uses advertising and packaging to convince consumers that its product differs from and is better than other products. These differences can be real or perceived.
- Advertising Expenditures
The cost of selling a good can represent a large portion of the price that consumers pay for a product.
- Selling Costs and Total Costs
Selling costs, such as advertising expenditures are fixed costs and increase total costs. These expenditures shift the average total cost curve upward. If advertising expenditures increase sales enough, the average total cost of the amount produced might decrease.
- Selling Costs and Demand
Advertising might increase demand for a firm’s product (by taking away other firms’ customers) or might decrease demand (as new firms enter the market trying to earn an economic profit).
C. Using Advertising to Signal Quality
A signal is an action taken by an informed person (or firm) to send a message to uninformed people. A firm uses advertising to signal consumers that its product differs from and is better than other products.
D. Brand Names
Brand names provide information to consumers about the quality of a product and provide an incentive to producers to keep the quality high and consistent.
E. Efficiency of Advertising and Brand Names
Whether advertising and brand names lead to efficiency is ambiguous. We must compare the benefits of the information provided by these means with the opportunity cost of the additional information.