Informative advertising in monopolistically competitive markets

Abstract

Firms spend a half-trillion dollars advertising each year. To model and examine the welfare effects of advertising with heterogeneous goods Grossman and Shapiro (1984) model informative advertising in monopolistic competition find that informative advertising is socially excessive for large numbers of sellers. However, it has been noted that their equilibrium may not exist. We present a tractable model of informative advertising in monopolistic competition replacing the standard assumption of a finite number of firms with a continuum of firms. We derive conditions for equilibrium existence and find that in the monopolistically-competitive model, informative advertising is socially insufficient. We also find that with free entry, the measure of the set of active firms is lower than the socially optimal one. The comparison of our results with the results of Grossman and Shapiro (1984) also shows that a pure-strategy, symmetric equilibrium typically does not exist in the latter model if the number of sellers is large, a fact which accounts for the different conclusions drawn in the two papers.