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The Economics of
Organisations and Strategy
Chapter 13
Product Differentiation and Advertising
The Economics of
Organisations and Strategy
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Chapter 13 - Question 1
Chamberlain’s model of monopolistic competition assumes
negligible cross price elasticities of demand which are implied
by the assumption of zero conjectural variations. The purpose
of this assumption is to:
A
Ensures consumers are well informed about
alternatives;
B
Limit the substitutability between products;
C
Enable firms to determine profit maximising output;
D
Create scope for horizontal demand curves.
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Chapter 13 - Question 2
One approach to dealing with the problem of limited
substitutability is the concept of a product space.
The model’s two axes show:
A
Horizontal and vertical differentiation;
B
Horizontal and vertical distance to market;
C
Horizontal and vertical boundaries for rivals;
D
Horizontal and vertical integration.
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Chapter 13 - Question 3
A1
X
Y
Z
E
B
In Lancaster’s attributes
model starting at point E, if
the price of receiving the
attributes A1 and A2 rises,
where will the consumer
move to:
A
A
D
0
V0
C
V1
A2
C
;
or ;
B
;
D
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Chapter 13 - Question 4
Consumption of a Veblen good is based in part on
the notion of conspicuous consumption. In this
respect it is an extreme form of:
A
A bandwagon effect;
B
Horizontal differentiation;
C
Spatial differentiation;
D
Vertical differentiation.
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Chapter 13 - Question 5
The equation provides the
formula for:
A
p - c. 
QA
=
pQ
p
A
Optimal advertising intensity;
B
Brand advertising;
C
Maximum advertising
intensity;
D
Profitable advertising.
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Chapter 13 - Question 6
As a source of information, advertising serves which
of the following purposes:
A
All of the following;
B
Information on individual sellers;
C
Information on a product’s attributes;
D
It helps potential customers evaluate offerings.
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Chapter 13 - Question 7
Which of the following could not be used as a
justification for using advertising to change
consumers’ preferences:
A
Consumers’ tastes are constantly changing;
B
Individuals are the best judges of their
own welfare;
C
Consumers benefit from perfect information;
D
Advertising by a firm implies faith in it’s
quality claims.
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Chapter 13 - Question 8
Advertising intensity has been linked to market structure.
Which of the following most accurately describes the
relationship between concentration and advertising intensity:
A
B
As concentration declines advertising intensity at
first falls and then rises;
As concentration increases, advertising intensity
follows an inverted U-shape;
C
As concentration declines, advertising intensity
rises;
D
As concentration rises, advertising intensity follows
a U-shape.
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Chapter 13 – Answer 1
Correct answer: When considering differentiated
products, the issue that needs to be addressed is
just how many product varieties should an industry
produce. Without some mechanism for limiting the
substitutability between products the cross price
elasticity will be very high, implying effectively that
each firm faces a horizontal demand curve for its
product. Limited substitution is necessary to
deliver a downward sloping demand curve.
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Chapter 13 - Answer 2
Correct answer: The vertical axis shows vertical
differentiation, the horizontal axis horizontal
differentiation. Moving up the vertical axis reflects
an increasing quantity of quality attributes and
therefore higher production costs. Moving along
the horizontal axis implies the same quantity of
quality attributes, but products are differentiated by
design, packaging and taste.
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Chapter 13 - Answer 3
Correct answer: The rays 0X, 0Y and 0Z show the
quantities of the attributes A1 and A2 delivered by
the three X, Y and Z. If the price of Y rises the
consumer will be forced to move down the ray
towards the origin. However, given the preference
map instead of moving to A the consumer will seek
the combination of A1 and A2 that delivers the
highest level of satisfaction; namely point C which
must lie on a higher indifference curve than point
B.
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Chapter 13 - Answer 4
Correct answer: the notion of conspicuous
consumption arises from the idea that a
consumer’s utility is enhanced by the belief that
in the eyes of others, consumption confers
considerable affluence and it is this attribute
that is highly valued by consumers. The more
vertically differentiated a product the greater its
value.
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Chapter 13 - Answer 5
Correct answer: The equation shows the
Dorfman-Steiner condition for optimal
advertising intensity – that is the ratio of
advertising expenditure (A) to the value of sales
(pQ). This is determined by the product’s pricecost margin multiplied by the elasticity of
demand with respect to advertising.
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Chapter 13 - Answer 6
Correct answer: In a world of asymmetric
information and bounded rationality, advertising can
serve the purpose of providing information.
Specifically it can inform potential buyers of the
existence of individual sellers, it can provide details
on the nature and characteristics of a product’s
attributes and it can help potential customers
evaluate quantity and price.
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Chapter 13 - Answer 7
Correct answer: Advertising has no purpose in a
world of perfect information. Advertising devoted
to building a band image is essentially attempting
to help potential customers identify quality before
they purchase. Only a firm that produces a quality
product can afford the cost of advertising,
otherwise having sample the product consumers
will not repeat purchase if it disappoints.
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Chapter 13 - Answer 8
Correct answer: Empirical studies show that
monopolists tend to have a lower level of
advertising intensity than oligopolists. For
oligopolists optimal advertising depends on a
firm’s conjectures regarding expenditure by rivals
which cause the level of advertising intensity to
rise excessively. As market structure moves
towards monopolistic competition and on towards
perfect competition, so the optimal level of
advertising intensity declines.
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