Question: A small group of companies operate in an industry where all firms face the average cost function AC = 40+1,250q-1 where q is output per week. This function refers only to production costs. They then decide to launch an advertising campaign, not just to try to increase sales but also to try to raise the total average cost of low output levels and deter potential smaller-scale rival firms from competing in the same market. The cost of the advertising campaign is £2,000 per week per firm and any competitor would have to spend the same sum on advertising if it wished to compete in this market.
(a) Derive a function for the new total average cost function including advertising, and sketch its approximate shape.
(b) Explain why this advertising campaign will deter competition if the original companies sell a 100 units a week at a price of £100 each and new competitors cannot produce more than 25 units a week.