Final answer:
Deciding on increasing an advertising budget in a perfectly competitive market requires analysis of short-term sales benefits and the potential for an offsetting advertising arms race as highlighted by A. C. Pigou.
Step-by-step explanation:
Whether or not to increase the advertising budget in a perfectly competitive market depends on various factors, including the short-term sales goals and the overall marketing strategy of the company. In a perfectly competitive market, all firms sell a homogeneous product, and the prices are determined by the market. Creating an aggressive advertising campaign may differentiate your product from competitors and increase demand, leading to potentially higher sales in the short run.
However, it is critical to note that long-term reliance on advertising in such markets may not yield the same benefit, as competitors can also increase their advertising efforts, leading to an advertising arms race which may only offset the gains made by each individual firm's advertising. Economist A. C. Pigou suggested that extensive advertising might serve merely to neutralize the advertising of competitors, rather than to significantly boost long-term profits. Therefore, a nuanced approach considering both the temporary benefits and potential long-term implications is essential when deciding on advertising expenditures.