Demand Faced by Monopolistically (Imperfectly) Competitive Firm

The market demand is the result of a horizontal summation of theindividual buyer’s demand functions. The market demand function canbe divided among the sellers. A simplified example is shown in Figure. If 80 units are demanded in the market at a price of $5, a sumof 80 units isdemanded from thesellers in themarket. To simplify,assume 3 firms in the market. The demand for firm A’s product at $5 is 17units. The demandfor firm B’s output is30 units. Therefore,33 units of outputfrom firm C must bedemanded. If afourth firm enteredthe market, there isno reason to believethat the buyerswould desire more at a price of $5. The demand for one or all firms’products would necessarily shift to the left (decrease in demand) bythe same number of units that the entrant (firm C) would sell at thatprice.

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The entry of firms will mean each existing firm will have a smaller shareof the market and are faced by more substitutes. Entry implies thatthe demand each firm faces for its product will decrease (shift to theleft) and become relatively more elastic at each price.Each firm would like to capture a larger share of the market and makethe demand for its product more inelastic. Advertising is an attempt toalter buyers’ perceptions and increase the demand. Economistsidentify two types of advertising: informative and persuasive.

Informative advertising provides buyers with information aboutavailability, features and relative prices. It helps the market to performallocation processes. A grocery who advertises milk at $1.39 per gallonin its store (plant) at the corner of High Street and Broadway, hashelped the market to perform. Persuasive advertising is an attempt toalter preference functions. Driving a new SUV makes one a member ofthe right social group. Smoking a (given brand) makes one sexier ormore macho, independent or whatever. It is not clear that persuasiveadvertising improves the ability of the market to allocate resources.It must also be noted that advertising increases the costs of the firmand alters the output decisions and profits.