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IAI Actuarial Core Principles · Business Economics · Profit maximisation under imperfect competition

Several Indian private health insurers are monopolistically competitive and spend heavily on advertising and brand building. Which is the most appropriate economic interpretation of this non-price competition?

Advertising and brand building are non-price competition that differentiates products, raising demand and making it less price elastic for each insurer. It also raises average costs, and because entry is free, any abnormal profit tends to be eroded in the long run.

  1. AIt differentiates products and shifts or makes each firm's demand less elastic, though it adds to average costsCorrect
  2. BIt proves that the firms are perfectly competitive price takers
  3. CIt guarantees permanent abnormal profit since entry is impossible
  4. DIt reduces marginal cost to zero for each firm
  5. It indicates that the firms have formed a legal monopoly

Explanation

Advertising and branding aim to differentiate the product, raising demand and making it less price elastic. This raises costs, and with free entry rivals imitate or enter, so abnormal profits tend to be competed away. The other options contradict the features of the market structure.

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