Final answer:
Advertising is considered a dominant strategy for firms in monopolistic competition because it makes the demand curve more inelastic or increases demand. If one firm does not advertise, it may lose market share to the advertising firm. Yet, simultaneous advertising by both firms can neutralize the overall effect.
Step-by-step explanation:
In a scenario where two firms are considering advertising, and their payoff matrix suggests that advertising is a dominant strategy for both firms, this is the case because through advertising, a firm can either make its demand curve more inelastic or increase its demand. This leads to the ability to either sell at a higher quantity or at a higher price, thus maximizing profits.
If one firm chooses not to advertise, it may lose potential customers to the rival who increases its market share through advertising efforts. This is due to the fact that without advertising, the firm cannot effectively communicate differentiations of its product or increase its perceived demand against the competitor's active promotions. In such a case, even if both firms would have been equally positioned in the absence of advertising, the firm choosing to advertise gains an advantage.
However, it is also possible that if both firms advertise aggressively, the competitive efforts may neutralise each other leaving the industrial position unchanged, as both firms' efforts to attract customers away from the other cancel out. This outcome is especially probable in markets characterized by monopolistic competition.