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Advertising Expenditure

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When advertising expenditure is increased, which of the aggregate and average (cost and revenue) curves shift their positions? Explain the direction of the shift. As an industry moves from being a monopoly to a monopolistically competitive one (due to the entry of new competitors as the monopoly's patents expire, for example), what happens to the elasticity of the demand curve facing the firm? Why?

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Solution Summary

The solution explains the shifting of the position of the aggregate/average curves when advertising expenditure is increased. Also discussed is the effect of moving from a monopoly to a monopolistically competitive industry on the elasticity of the demand curve facing the firm. References included.

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Advertising expenditure is a form of non-price competition that can increase sales while price remains constant. The aim of advertising is to shift the demand curve rightward and make it less elastic. Advertising expenditures increase total costs thereby affecting the demand curve positively shifting it rightward (upward). Advertising increases demand and thereby increasing sales. The total costs (production, selling and distribution expenses) curve goes up as costs increase while the total sales/revenue curve goes upwards as advertising increases sales and then towards the right because diminishing returns to increased advertising may well set in after some point. Advertising shifts the demand curve outward and raises the fixed costs by the amount that it has spent on advertising. Hence, advertising raises both costs and revenues and the optimal level of advertising balances additional revenues and additional ...

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