Non-price competition involves two major elements: product development and advertising. The major aims of product development are to produce a product that will sell well (i.e. one in high or potentially high demand) and that is different from rivals’ products (i.e. has a relatively inelastic demand due to lack of close substitutes). For shops or other firms providing a service, ‘product development’ takes the form of attempting to provide a service which is better than, or at least different from, that of rivals: personal service, late opening, certain lines stocked and so on.
The major aim of advertising is to sell the product. This can be achieved not only by informing the consumer of the product’s existence and availability, but also by deliberately trying to persuade consumers to purchase the good. Like product development, successful advertising will not only increase demand, but also make the firm’s demand curve less elastic since it stresses the specific qualities of this firm’s product over its rivals’.
Product development and advertising not only increase a firm’s demand and hence revenue, they also involve increased costs. So how much should a firm advertise, to maximize profits?
For any given price and product, the optimal amount of advertising is where the revenue from additional advertising (MRA) is equal to its cost (MCA). As long as MRA > MCA, additional advertising will add to profit. But extra amounts spent on advertising are likely to lead to smaller and smaller increases in sales. Thus MRA falls, until MRA = MCA. At that point, no further profit can be made. It is at a maximum. Two problems arise with this analysis:
•The effect of product development and advertising on demand will be difficult for a firm to forecast.
•Product development and advertising are likely to have different effects at different prices. Profit maximization, therefore, will involve the more
complex choice of the optimum combination of price, type of product, and level and variety of advertising.
Excess capacity (under monopolistic competition) in the long run, firms under monopolistic competition will produce at an output below their minimum-cost point. Comparison with perfect competition it is often argued that monopolistic competition leads to a less efficient allocation of resources than perfect competition. The arguments here are very similar to those when comparing perfect competition and monopoly.
On the one hand, freedom of entry for new firms and hence the lack of long-run supernormal profits under monopolistic competition are likely to help keep prices down for the consumer and encourage cost saving. On the other hand, monopolies are likely to achieve greater economies of scale and have more funds for investment and research and development.