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CFA Level I · CFA Level I Exam · The Firm and Market Structures

A monopolistically competitive firm increases its advertising spending. Holding other factors constant, the effect most likely to occur on its cost and demand is that average total cost:

Average total cost rises at every output level, while demand may become less elastic and shift right. Advertising adds fixed cost, lifting ATC, but it aims to differentiate the product and strengthen brand loyalty, which can raise sales and reduce customers' price sensitivity.

  1. Arises at every output level, and demand becomes more elastic
  2. Brises at every output level, and demand may become less elastic and shift rightCorrect
  3. Cfalls at every output level, and demand shifts left

Explanation

Advertising is a fixed cost, so ATC rises at every output level. Its aim is to differentiate the product and build brand loyalty, which can shift demand right and make it less elastic. If sales rise enough, ATC per unit can still fall, but the cost curve itself is higher.

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