Final answer:
A firm can handle volatility by increasing advertising during booms, but there are various strategies to increase demand depending on the market structure, including product differentiation and quality improvements. In monopolistic competition, advertising affects demand elasticity and quantity, while in perfect competition, its role is limited due to the homogeneity of products.
Step-by-step explanation:
Increasing advertising expenditure during economic booms is one way an industrial firm can manage the inherent volatility of the industrial sector. However, in a monopolistically competitive market, aside from advertising, firms can increase demand for their products through product differentiation, improving product quality, enhancing customer service, or implementing loyalty programs. In contrast, a company in a perfectly competitive market might consider whether an aggressive advertising campaign is beneficial since products are largely identical and price competition is the primary driver of sales.
Advertising works on the principle of making consumers believe that one firm's products are differentiated from another's. It can cause a firm's perceived demand curve to become more inelastic—resulting in steeper demand—or it can cause demand for the firm's product to increase, shifting the demand curve to the right. As noted by economist A. C. Pigou in 1920, there is also the consideration that much advertising may simply offset the effects of competitors' advertising.
In the long run, firms in a monopolistically competitive market are unlikely to sustain economic profits or losses due to entry and exit of firms responding to market conditions. Advertising can temporarily increase profits by causing a rightward shift in demand or making the perceived demand curve steeper, allowing firms to sell more or at higher prices. Still, these effects might be balanced out by increased competition and other firms' advertising efforts.