The Effects of Advertising on Profits

This essay is going to examine how advertising strategies used in different market structures affects profits of the firms. This essay is being written based on Advertising, an article by Geoff Stewart, in which he examines “how do firms determine their advertising strategy”. In this article he uses Monopolies as an example of a non-competitive market and Oligopolies as an example of competitive markets, so in this essay Monopolies and Oligopolies will also be used as examples. However other competitive markets include perfect competition and monopolistic competition.

A Monopoly is a market structure characterised by one firm and many buyers, a lack of substitute products and barriers to entry (Pass et al. 2000). An oligopoly is a market structure characterised by few firms and many buyers, homogenous or differentiated products and also difficult market entry (Pass et al. 2000) an example of an oligopoly would be the fast food industry where there is a few firms such as McDonalds, Burger King and KFC that all compete for a greater market share.

In a Monopoly there is one firm that controls the market, and there is no similar products being sold by other companies. Advertising is therefore used to encourage people to buy more of their product. In a monopoly there is a downward sloping demand curve, the reason for this is that a firm must lower the price to sell and extra unit of their product. For a monopoly to maximise profits it must have an equilibrium point where marginal cost equals marginal revenue, there is no reason for a firm to move from this equilibrium point because they are fulfilling their market plan. Using Figure 1 (Stewart, 2005) it can be explained why a monopoly firm would advertise. Marginal cost is fixed and is the line MC and demand is line D, marginal revenue is line MR. As the firm wishes to profit maximise it sets output at level Qm where marginal revenue crosses marginal cost, this means price is set at Pm where the quantity reaches the demand curve. If a firm is going to advertise it is likely that it will cause demand to shift to the right, this is because more people are going to buy the product when it is being sold at the same price. This is represented by the shift D to D’.