Mostly summarized from Gregory Mankiw’s Principles of Economics, 5^th Ed.

PART 5 Firm Behavior and the Organization of Industry

Chapter 16 of 36 Monopolistic Competition   

Section 14 of 15

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In many markets there are two types of firms

· firms that sell products with widely recognized brand names

· firms that sell generic substitutes

In a grocery store, you find Pepsi next to unfamiliar colas.

Mostly, the firm with the brand name spends more on advertising and charges a higher price for its product.

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There is disagreement about the economics of brand names.

Critics argue brand names cause consumers to perceive non-existent product differences.

Often the generic good is indistinguishable from the brand-name good.

They argue consumers' willingness to pay more for the brand-name good is an irrationality caused by advertising.

Economist Edward Chamberlin in 1933 concluded brand names were bad for the economy.

He proposed government discourage use of brand names by refusing to enforce the exclusive trademarks companies use to identify their products.

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Most economists have defended brand names as a useful way for consumers to know goods are high quality.

Brand names provide consumers with information about quality when quality cannot be easily judged before buying.

Imagine you are driving through an unfamiliar town and want lunch and you see a McDonald's and a local restaurant next to it.

The local restaurant may actually have better food at lower prices, but you have no way of knowing.

But you know McDonald's offers a consistent product at all its restaurants.

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Brand names incentivize firms to maintain high quality, because firms have a financial stake in maintaining their brand names’ reputation.

If some customers were to get sick from bad food sold at a McDonald's, the news would cause great injury to the company.

McDonald's would lose much of the valuable reputation it has built up over the years.

It would stand to lose sales and profit not only in the restaurant that sold the bad food but at all its outlets.

If some customers were to get sick from bad food at a local restaurant, that restaurant might have to close but the value of lost business would be much smaller.

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The debate over brand names centers on the question: are consumers rational in preferring brand names to generic substitutes?

Critics argue brand names result and benefit from an irrational consumer response to advertising.

Defenders argue consumers have good reason to pay more for brand name products, because they can be more confident in the quality.