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

Which statement about advertising and branding in monopolistic competition is most accurate?

Non-price competition such as advertising and branding can make demand less elastic, but it raises costs and rivals can imitate it. With free entry, abnormal profit is still competed away in the long run, so it does not guarantee lasting abnormal profit.

  1. ANon-price competition can make demand less elastic but raises costs, so it may not preserve abnormal profitCorrect
  2. BAdvertising is irrelevant because products are identical
  3. CAdvertising always lowers average cost enough to raise long-run abnormal profit
  4. DFirms never compete on quality since price is the only variable
  5. Advertising makes the demand curve perfectly elastic

Explanation

Branding and advertising aim to make demand less elastic and shift it right, but they add to costs. Rivals copy such strategies and entry continues, so long-run profit tends towards normal. Products are differentiated, not identical.

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