Question

Suppose that, due to a successful advertising campaign, a monopolistic competitor experiences an increase in demand for its product. How will that affect the price it charges and the quantity it supplies?

Short answer

In response to the successful advertising campaign, the monopolistic competitor experiences an increase in demand for its product, causing the demand curve to shift to the right. To reach a new equilibrium, the firm adjusts its quantity supplied, resulting in a higher quantity being produced and supplied. Alongside this, the firm can now charge a higher price for its product due to the increased demand. Therefore, the advertising campaign leads to an increase in both the price charged and quantity supplied by the monopolistic competitor.

Step-by-step solution

Understand monopolistic competition

In a monopolistic competition market structure, there are many firms producing differentiated products. Each firm has some degree of market power, which allows them to set their own prices. However, they are also competing with other firms that offer similar products, which limits their ability to charge excessively high prices.

Determine the initial equilibrium

Before the advertising campaign, the monopolistic competitor was already producing at an equilibrium point where its marginal cost (MC) was equal to its marginal revenue (MR). At this point, the firm maximizes its profit.

Analyze the increase in demand

Due to the successful advertising campaign, the demand for the firm's product increases, meaning that more consumers are willing to buy the product at each price level. This causes the demand curve to shift to the right.

Find the new equilibrium

After the increase in demand, the firm will adjust its quantity supplied to reach a new equilibrium point where its new marginal revenue (MR2) equals its marginal cost (MC). This results in a higher quantity being produced and supplied.

Determine the change in price

At the new equilibrium point, the price the monopolistic competitor can charge for its product is determined by the demand curve at the new quantity supplied. Because demand has increased, the firm can charge a higher price for its product.

Conclusion

As a result of the successful advertising campaign, the monopolistic competitor experiences an increase in demand for its product. This leads to a new equilibrium point where the firm supplies a higher quantity and can charge a higher price for its product.