Principle of Economics II: Microeconomics

 

Chapter 23 Notes

 

Review: Table 23-1, Page 468

 

Characteristic

Pure Competition

Monopolistic Competition

Oligopoly

Pure Monopoly

Number of Firms

Very Large Number

Many

Few

One

Type of Product

Standardized

Differentiated

Standardized or Differentiated

Unique

Control Over Price

None

Some

A lot if firms work together

Considerable

Conditions of Entry

Very Easy

Relatively Easy

Big Obstacles

Blocked

Nonprice Competition

None

Advertising, brand names, trademarks, etc.

A great deal, especially with differentiation

Public relations and advertising

Examples

Agriculture

Retail, dresses, shoes

Steel, cars, household appliances

Local Utilities

(water, electric)

 

-The same firm will operate differently according to the market structure it is in.

-This chapter deals mainly with pure competition.

 

Pure Competition

 In pure competition, the behavior of a single firm has no significant effect on supply. The demand in pure competition is perfectly elastic – the market will by any amount of a product at equilibrium price that the firm can produce – and the demand curve is horizontal.

 

Review:

Marginal Revenue – the revenue gained from selling one more unit. Marginal Revenue equals the change in total revenue divided by the change in quantity.

MR = DTR ¸ DQ

Average Revenue – revenue per unit of production. Average Revenue equals total revenue divided by quantity.

AR = TR ¸ Q

When the elasticity of demand is perfectly elastic, the demand curve, the marginal revenue, the average revenue, and the price of the last unit sold are all equal. The first three are represented by the same horizontal line on the graph at market equilibrium price. The price of the last unit sold is a POINT on the firm's demand curve at the quantity the firm decides to sell.

 

Refer to graph a, figure 23-2, page 473.

Where total cost intercepts total revenue are the two (and only two) break-even points. Here, the firm realizes normal profit.

At what level of production will economic profits be maximized?

Maximum Economic Profits are realized when there is the greatest difference between total cost and total revenue. Here, the slopes of the total cost and total revenue lines are equal.

The slope of total revenue equals the change in total revenue (the rise) divided by the change in quantity (the run).

Slope of TR = DTR ¸ DQ

The slope of total cost equals the change in total cost divided by the change in quantity.

Slope of TC = DTC ¸ DQ

If the slope of total revenue is greater than the slope of total cost, economic profits are increasing.

If the slope of total revenue is less than the slope of total cost, economic profits are decreasing.

If the slope of total revenue is equal to the slope of total cost, economic profits are at their maximum.

Note: There may be cases where MR=MC at two different quantities, one near zero and one farther out to the right. Which one is the profit maximizing point? At the point on the left, for the next unit of output, the slope of total revenue is greater than the slope of the total cost, so increasing output would increase profits. At the point on the right, for the next unit of output, the slope of total revenue is less than the slope of the total cost, so increasing output would decrease profits. Therefore, the point on the right is clearly the profit-maximization level of output.

So, when DTR ¸ DQ = DTC ¸ DQ, Quantity (Q) represents the level of production at which maximum economic profits are realized.

 

Confused? There’s another way to look at it.

 

Review:

Marginal Revenue equals the change in total revenue over the change in quantity.

DTR ¸ DQ = MR, and

DTR ¸ DQ = Slope of TR, so

MR = Slope of TR

Marginal Cost equals the change in total cost over the change in quantity.

DTC ¸ DQ = MC

DTC ¸ DQ = Slope of TC, so

MC = Slope of TC

When marginal revenue equals marginal cost (MR = MC), this also is the point at which maximum economic profits are realized.

But we still do not know if this firm is making any profit. To find out, we need to compare revenue and cost. Refer to figure 23-3, page 475.

Maximum economic profit is where MR = MC, which is at a quantity of 9 in this case.

Review:

Economic Profit is equal to total revenue minus total cost. (Economists usually use the symbol p, the Greek letter "pi," to denote economic profit. Don't confuse this with its mathematical use, i.e., 3.14)

p = TR – TC

Total revenue is equal to average revenue times quantity, and total cost is equal to average cost times quantity, and we have

p = (AR – ATC)×Q

AR = 131 (remember AR = MR = D = P when there is perfect elasticity), ATC = 97.78, Q = 9

(131 – 97.78)×9 = p ×

(33.22)×9 = p

298.98 = p

The firm is realizing an economic profit of $298.98 at 9 units of production.

 

What if the market price decreases? See figure 23-4, page 476

If the market price decreased to $81, the demand curve is below average total cost.

The level of output for maximum economic profits is 6 units (MC = MR).

 

Should the firm produce at 6 units or stop production? (Remember that we are dealing with the short run. Exiting the industry is a long-run decision.)

If the firm stops production, the loss will be equal to fixed costs (e.g., still have to pay rent, taxes, and other fixed costs, even if they don't produce ANY output).

Economic profit is equal to total revenue minus total variable costs minus total fixed costs.

p = TR – TVC – TFC

Economic profit is also equal to average revenue minus average variable costs minus average fixed costs, times quantity.

p = [(AR – AVC) – AFC]×Q

If average revenue is greater than average variable costs (AR > AVC), then the firm will lose less than total fixed costs and continue production at 6, minimizing economic losses.

If average revenue is less that average variable costs (AR < AVC), then the firm will lose more than the total fixed costs by continuing production and will shut down to minimize losses.

If average revenue is equal to average variable costs (AR = AVC), then the losses will be the same whether or not the firm continues production. In this class, we assume the firm continues to produce.

 

This Example:

[(AR – AVC) – AFC]×Q = p, AR = P = $81, AVC = $75, AFC = $16.67, Q = 6

[(81 – 75) – 16.67]×Q = p

[6 – 16.67]×6 = p

[-10.67]×6 = p

-64.02 = p

Since -64.02 > -100.00, the firm should continue to produce at Q = 6 to minimize losses.

 

 

 

Principles of Economics II: Microeconomics

Principles of Economics II: Microeconomics

 

Chapter 22 Continued…

 

Remember:

Where marginal cost equals marginal revenue is the point of maximum economic profit.

MC = MR

At this level of output, average economic profit (or loss) equals average revenue minus average total cost (AR - ATC), and total profit equals average profit times the quantity {(AR - ATC)(Q)}, i.e., (TR - TC).

 

Short-Run Profit Maximization Criteria for a firm in ANY of the four market models:

Question

Marginal Revenue - Marginal Cost Approach

What quantity should the firm produce to maximize profits?

Find Q*, where Marginal Revenue equals Marginal Cost, and the MR of the next unit would be less than the MC of that unit. This is the quantity that the firm will produce to maximize profits, if it operates in the short run.

Should this firm produce?

Draw a vertical line at beginning at Q* up through the entire graph. Set P* (the price of the last unit sold) equal to Demand at Q*. Compute Average Revenue. If Average Revenue is greater than or equal to Average Variable Cost, produce Q*, else, produce zero, i.e., shut down.

Will production result in economic profit?

Yes, if Average Revenue exceeds Average Total Cost. No, if Average Total Cost Exceeds Average Revenue.

 

Supply Curve

Look at Figure 23-7, page 479. The supply curve and the marginal cost curve are equal. The supply curve of the entire industry has the same shape and is proportionate to the supply curve of a single firm. The firm will produce where marginal cost crosses marginal revenue (MC = MR), and the industry will produce where supply intercepts demand (

Long Run Equilibrium

S = D). Equilibrium occurs at the minimum average total cost for each firm (figure 23-8a, page 472).

 

The Long Run Supply for a Constant-Cost Industry

 

Increasing Demand See Figure 23-8b, page 482

1,000 firms in an industry are producing a total of 100,000 units at $50 each (S1 and D1) and earning an economic profit of 0 (nominal profits). Demand increases (to D2) and the price increases to $60, these businesses are now making an economic profit. 100 more firms see the profits and enter the industry, increasing supply (S2) and the price falls back to equilibrium at $50. Now there are 1100 firms producing a total of 110,000 units and making normal profits.

Simplified: Demand increases: equilibrium price increases: firms make economic profits.

Firms enter industry: supply increases: price decreases to original equilibrium: no economic profits (normal profits).

 

Decreasing Demand See figure 23-9, page 483

1,000 firms make a total of 100,000 units at $50 (S1 and D1) and earn normal profits. Demand decreases (to D3) and the price decreases to $40, these businesses are losing money. 100 firms exit the industry, decreasing supply (to S3) and the price rises back to equilibrium at $50. Now there are 900 firms producing a total of 90,000 units and making nominal profits.

Simplified: Demand decrease: equilibrium price decreases: firms lose money.

Firms leave industry: supply decreases: price increases to original equilibrium: no losses (normal profits).

 

Long-Run Supply for a Constant-Cost Industry Look at Figure 23-10, page 484

Notice that, in the long run, the price always went back to $50. Even when more firms entered the industry, or some firms left, each firm's cost of producing 100 units remained the same. This is called a Constant-Cost Industry. The average total cost line never changed and the minimum average total cost remained the same, so that the long-term equilibrium price is always $50, and the supply curve is represented by a horizontal line.

Long-Run Supply for an Increasing-Cost Industry

What if, as more firms entered the industry, resources became more expensive? Now, the cost of producing the same number units would increase.

 

 

Increasing Demand

When demand increases, the price increases to $60 and firms enjoy short-term economic profits. Other firms enter the industry, increasing supply, and decreasing price. But now, as resources become scarce and more expensive, the cost of production increases, so that we shift from ATC1 to ACT2. Instead of going back to $50, the equilibrium price now becomes $55, the new minimum average total cost.

 

Decreasing Demand

When demand decreases the price decreases to $40 and firms suffer short-term losses. Some firms leave the industry, decreasing supply and increasing price. But now, as resources become less scarce and less expensive, the cost of production decreases so that we shift from ATC1 to ATC3. Instead of going back to $50, the equilibrium price now becomes $45, the new minimum average total cost.

 

Long-Run Supply for an Increasing-Cost Industry Look at Figure 23-11, page 485

Notice that, in the long run, the price gradually increased as more firms entered the industry or decreased when some firms left. The cost of producing the same 100 units increased and decreased with the number of firms. This is called an Increasing-Cost Industry. The average total cost line shifts upward and the minimum average total cost increases when firms come into the industry, so that the long-term equilibrium price increases and the supply curve and has a positive slope.

 

Long-Run Supply for a Decreasing-Cost Industry

 

This scenario is rare, but it can occur. The text gives the example of a mining industry, where the increased number of firms decreases transportation costs to each firm. A decreasing-cost industry has a down-sloping long-run supply curve.

 

 

 

 

2-23-99

Principle of Economics II: Microeconomics

 

Chapter 23 Continued…

 

Review:

Productive Efficiency – in Chapter 3, productive efficiency was achieved at any point on the productions possibilities curve, the cheapest way to produce goods and services.

Allocative Efficiency – it is the combination of goods and services that is most desired by society (consumers) in Chapter 3.

 

Pure Competition and Efficiency

Productive Efficiency – is achieved automatically in pure competition. Firms are forced to produce where price equals minimum average total cost (P = Minimum ATC). Firms that do not use least-cost methods of production will charge higher prices and go out of businesses. Only firms that use the most efficient methods of production will remain in business.

Allocative Efficiency – is also achieved automatically in a pure competition market structure. Remember that the price of a product represents its worth, or benefit to society, and the marginal cost is the cost of making an additional unit. In Chapter 21, the individual consumer gained the maximum utility ("bang for the buck") when the marginal utility (measure of gain) of the last unit bought equaled the price (cost). It is a similar case here. Society gains the maximum benefit when the price (measure of worth or gain) equals the marginal cost (P = MC).

Underallocation – price is greater than marginal cost (P > MC). Consumers are paying more than it costs the firms to produce, firms are not producing enough to suit the needs of society (demand > supply; there is a shortage). Firms could make more money if they produced more.

Overallocation – price is less than marginal cost (P < MC). Consumers are paying less than it costs the firms to produce, firms are producing too much (demand < supply; there is a surplus). Firms would reduce loss if they made less.

Dynamic Adjustments – this refers back to productive efficiency. An improvement in technology that reduces the cost of producing a good or service will reduce the prices of goods made by firms that use it. Firms that do not use this technology will be unable to make even normal profits at the market price and will be forced to exit the business. Only the firms that use the most cost efficient technology can remain in business in a purely competitive market structure.

 

* Firms want to make the most amount of money; consumers want to pay the least amount of money. This conflict of interest in a pure-competition market structure provides for the most efficiency (if there are no spillovers).

 

Spillover (External) Costs and Benefit – remember that these costs and benefits are not assumed by the firm but spillover into society. The government must interfere in these cases to reflect the true costs and benefits to society.

 

* A major disadvantage of the pure-competition market structure is that all units of production must be the same. If, for instance, clothes were a part of pure competition, every one would were the same clothes. Instead, clothes are a part of monopolistic competition.

 

 

Chapter 24 – Pure Monopoly

- The demand curve for a firm in a monopolistic market is the market curve (there is only one firm in a monopolistic market).

See Table 24-1, page 498.

If a firm wants to sell its product as it is listed on the table (1st at $162, 2nd at $152, etc.) it would have to be able to tell the first consumer who would pay $162 from the tenth consumer who would pay only $72. If it can’t, the firm must sell every unit it produces for the same price. This is called a "single price monopolist."

Price Discrimination – charging different prices to different people for the same product.

The firm may set the price at $162 and haggle with those consumers who are unwillingly or unable to pay that much. If it could find which customer is willing and able to pay $152, $142, $132, etc., then it could engage in price discrimination. We will see an example of perfect price discrimination later. Some other forms of price discrimination is when movies, airlines, phone companies, etc., set different prices for different groups of people (adult/child, business traveller/vacation traveller, day/night).

But most charge the same price to each consumer for each unit of production. See graphs a and b, figure 24-3, page 500.

Remember that the marginal revenue is the slope of the total revenue (MR = Slope of TR). Note that where marginal revenue is greater than zero (MR > 0), the demand is elastic, and where the marginal revenue is less than zero (MR < 0) the demand is inelastic. Where the marginal revenue equals zero (MR = 0) is the maximum total revenue.

Firms will not produce where the demand curve is inelastic (unless forced to) for two reasons.

  1. The marginal revenue is negative (MR < 0).
  2. Firms produce at the point where marginal revenue equals marginal cost (MR = MC; maximum economic profit) and marginal cost cannot be less then zero.
Principles of Economics II: Microeconomics

Principles of Economics II: Microeconomics

 

Chapter 24 Continued…

 

Review:

In Order to determine if a Firm should stay in Business

  1. Determine point of greatest economic profit. Where Marginal cost equals marginal revenue (MC = MR)
  2. Determine the price. Price is set at where demand equals production (Q* = D)
  3. Determine profit. The difference between average revenue and average total cost times quantity equals ({AR – ATC} Q = Economic Profit {Loss}).

If Economic Profit (Loss) is positive, continue to produce at Q*.

If Economic Profit (Loss) is negative, are you covering average variable costs?

Keep in mind that average revenue minus average variable costs minus average fixed cost times quantity equals economic profit ([{AR – AVC} – AFC] Q = EP).

If Average Revenue minus Average Variable Costs is positive (AR – AVC > 0), produce at Q*.

If Average Revenue minus Average Variable Costs is negative (AR – AVC < 0), do not produce.

 

Economic Effects of Monopoly (see graph on bottom-right of page 504)

In a pure competition market structure, the 200 firms would produce where supply equals demand (S = D). They would make Qc many units and charge Pc for each unit.

In a monopoly, the one firm would produce where there is greatest economic profit, where marginal cost equals marginal revenue (MC = MR). This firm would make Qm many units, significantly less than Qc. This firm would charge Pm for each unit, significantly more than Pc.

Unregulated monopolists make fewer products and earn more money. The price is greater than the marginal cost (P > MC) and resources are underallocated; there is not allocative efficiency. For productive efficiency, the industry should produce where price equals minimum average total cost (P = minimum ATC). In order to make the most economic profit, the monopolistic firm will produce at MC = MR, this is not necessarily where price equals the minimum average total cost (P = minimum ATC). Price must be greater than average total cost to make economic profit, and there is not productive efficiency.

 

Income Distribution

Usually, those who own monopolistic companies are rich. They hike up the prices, forcing the poor to pay more, and gain more money. The income distribution gets more uneven as the rich grow richer and the poor grow poorer.

This is not always the case. Sometimes, the not so rich will own a monopoly and only the rich can afford the product. For example, some middle-class people own the stock for "Yachts and Accessories, Inc." This business has a contract with the yacht club, giving them a franchise monopoly. The rich members of the yacht club buy yachts and stuff from his company. The income distribution becomes more level as the rich spend money and the poor make money.

 

3-01-99.doc

Principle of Economics II: Microeconomics

 

Chapter 24 Continued…

 

Review:

Firms produce the quantity (Q*) where marginal revenue equals marginal cost (MR = MC). The price of the product is where the quantity equals the demand (Q* = D).

What if the monopolistic firm is making economic profit (p )? Other firms will attempt to enter the industry. Entry is blocked and they will most likely fail to enter. If they succeed, this industry is no longer a monopoly and another model is used.

What if the monopolistic firm is making economic losses (-p )? The firm will continue to produce if is can still cover its average variable cost (AVC). If not, the firm will discontinue production. When a monopolistic firm goes out of business, there is no longer that particular industry.

Purely competitive markets produce where supply equals demand (S = D). Monopolistic markets produce where marginal revenue equals marginal cost (MR = MC) which causes underallocation of resources. They don’t make enough of the product and charge too much. (Price is greater than marginal cost: P > MC).

Monopolistic firms are usually owned by the rich, forcing higher prices on the poor (or less rich). This is not always the case. Sometimes, the poor own the monopoly. For example, an opera may consist of performers who are not very well off, but the rich mostly attend the theater.

 

Inefficiencies of Monopolies

X-Inefficiency

When the average total cost curve is not the minimum average total cost curve. In other words, the firm is incurring costs and reducing profit when it doesn’t have to. These costs may be caused by incompetent workers or looking for the easy way out. Monopolistic firms are more susceptible the X-inefficiencies because there is urgent need to minimize costs due to little or no competition.

Rent-Seeking Behavior

Activities designed to transfer income or wealth to a particular firm at someone else’s or society’s expense. Examples: expensive office furniture, designer decorations such as a fountain in the lobby, legal fees paid to maintain the monopoly.

Dynamic Efficiency

Are monopolists or competitive firms more likely to develop more efficient production techniques in the long run?

For Competition

More competitive firms have more incentive to lower production costs and increase efficiency. This makes their places in the market more secure with less fear of losing money and going out of business. Monopolistic firms already have a secure place in the market.

For Monopoly

If a monopoly does not do a good enough job, it may lose the monopoly to another firm. Example: FPL decides to do a real bad and expensive job of providing South Florida with electricity. The government steps in and gives the monopoly to a Georgia power company who is minimizing its costs and prices. Another reason for a monopoly to be more dynamically efficient than a competitive firm is its economic profits. Some of this money is granted to research projects for more efficient production methods.

The Answer: There is no answer. We have a mixed picture.

 

Dilemma of a Regulated Monopoly (See figure 24-8, page 510)

A firm will produce where marginal revenue equals marginal cost (MR = MC). In a monopoly, the industry also produces here, at Qm and Pm. The government wants the industry to produce at Qr and sets a price ceiling at Pr. But at Pr, the marginal revenue (D = MR) is less than average total cost (ATC), the monopoly is losing money and will go out of business in the long run. There will be no product Q produced at all.

The best solution is to subsidize the monopoly the amount of its loss. The government officials who approve of this subsidy will anger the public ("Why is the government giving the monopoly more money?!") and will not get reelected. So the government sets a price ceiling where price equals average total cost (P = ATC) at Pf and the firm produces Qf. The monopoly is not making any economic profit, but it is making normal profits and will stay in business. Although the firm is not producing as much as the government wants it to, it is still producing more than it would have if left unregulated.

 

Perfect Price Discrimination

Three Conditions:

  1. The firm must have monopolistic power.
  2. The firm must be able to segregate buyers.
  3. The buyer must not be able to resale the product.

 

Price

Quantity

Total Revenue

Marginal Revenue

Average Revenue

11

0

0

0

0

10

1

10

10

10

9

2

19

9

9.5

8

3

27

8

9

7

4

34

7

8.5

 

The price discriminating monopolist makes more money (note that the average revenue AR is higher than the demand curve D) and produces more than the single-price monopolist.

The monopolist produces at the point where marginal revenue equals marginal cost (MR = MC), and because the marginal revenue and demand curves are the same, this point is also where the price of the LAST unit exchanged equals the marginal cost of producing that unit. (P* = MC). Thus, the unregulated price-discriminating monopolist provides allocative efficiency.

 

Principles of Economics II: Microeconomics

Principles of Economics II: Microeconomics

 

March 9, 1999

 

Monopolistic Competition

-Large number of sellers

-Easy entry and exit

-Product differentiation (real or perceived)

Remember that in a purely competitive market, the firms produce exactly the same products. The demand curve is perfectly elastic because substitution is great: Tom’s bushel of corn is the same as Jake’s so it doesn’t matter who I buy from). But in monopolistic competition, the products are different: Tom’s corn is watered with pure spring water and Jake doesn’t use pesticides on his corn. This makes the demand curve more inelastic which causes it to be down sloping.

Brand Loyalty – a monopolistic competitor may charge a little more than the market price because his/her customers will not buy any other brand name.

 

Production

A monopolistic competitor will produce at Q* where MC = MR. The firm will charge that price where Q* crosses the demand curve (Q* = D).

If the firm is making economic profits, other firms will enter the industry until economic profits are zero and firms in the industry are making normal profits.

If the firm is losing money will it continue to produce?

If the firm’s marginal revenue is less than average variable costs (MR < AVC), the firm will discontinue production in the short run and may exit the industry in the long run.

If the firm’s marginal revenue is greater than average variable costs (MR > AVC), the firm will continue to produce in the short run. Other firms will exit the industry in the long run until economic losses are zero and firms in the industry are making normal profits.

In the long run of monopolistically competitive markets, economic profits are zero.

 

Monopolistic Competition vs. Pure Competition

Allocative Efficiency

Remember that in pure competition (see figure 23-12, page 486) the demand curve is perfectly elastic (horizontal) and equals marginal revenue, average revenue and price (D = MR = AR = P). Allocative efficiency is when price equals marginal cost (P = MC). The price is determined where production Q* at MR = MC crosses the demand curve, which is the point where price equals marginal cost (since price and marginal revenue are represented by the same line) and there is allocative efficiency.

In monopolistic competition, (see graph c, figure 25-1, page 519) the demand curve is down sloping and the marginal revenue is not equal to it but below it. Price is determined where production Q* at MR = MC crosses the demand curve, which is above marginal cost. Price is greater than marginal cost (P > MC) so we don’t have allocative efficiency and there is underallocation of resources.

Productive Efficiency

Remember that productive efficiency is where price equals minimum average total cost (P = Minimum ATC).

In pure competition, firms produce at minimum average total cost in the long run (see graphs on pages 482 and 483 to review this). If the price goes up or down, profits go up and own and firms enter or exit the industry accordingly, profits return to normal profits, and firms produce at minimum ATC.

In monopolistic competition, firms produce where Q* crosses the demand curve, which is not at minimum ATC (see figure 25-2, page 521). Their quantity of production Q* is less than the quantity of production at minimum average total costs, and each unit costs more than the minimum cost to produce.

The difference between the quantity of production at Q* and the quantity of production at minimum average total cost is known as excess capacity. Monopolistic firms charge a higher price and produce less.

 

Advantages and Disadvantages of Monopolistic Competition

Utility

By differentiating the product, monopolistic competitors better suit the desires of society. Think how boring it would be if everyone had to where the same clothes because only one kind of shirt, shoes, shorts, etc. was produced.

By differentiating, the individual is faced with many choices of the same product. This can be confusing and time consuming.

Advertising

The traditional view is that advertising is a waste of time and resources. The amount of sales that would have been generated by advertising is negated by the fact that your competitor also advertises. Commercials merely push the consumer to buy a product rather than benefiting the consumer.

The new view is that advertising helps to inform the consumer about which product is better. How would you know that Ritz makes a reduced-fat cracker if you didn’t see it on television or on the box? And there are ways of calculating the effects of advertising.

Elasticity of Our Firm’s Advertising equals the percentage change in quantity demanded divided by the percentage change in the cost of advertising by us:

Ea = %D Qd ¸ %D Au

Ea is positive, indicating a direct relationship between quantity demanded and our advertising. The more we advertise, the more is demanded.

Cross Elasticity of Advertising (or Elasticity of Advertising by Them) equals the percentage change in quantity demanded divided by the percentage change in advertising by them:

Ea = %D Qd ¸ %D At

Ea is negative, indicating an inverse relationship between quantity demanded and their advertising. The more they advertise, the less is demanded of our product.

Elasticity of Advertising by the Industry is equal to the percentage change in quantity divided by the percentage change in advertising by the industry:

Ea = %D Qd ¸ %D Ai

Ea is positive here, indicating a direct relationship. The more the industry advertises, the more is demanded from the industry as a whole.

The cost of advertising may be a part of average total cost or average variable cost, depending on how it’s done. Television commercials may be considered ATC because they are a part of fixed cost. Pictures on the package (like cereal boxes) may be a part of AVC because the cost of advertising depends on how many are produced.

 

Empirical Evidence

Does advertising help?

Answer: There is no answer. There is data available to prove both answers to this question.