What is Monopolistic Competition?
Monopolistic competition is a market structure that lies between the extreme cases of competition and monopoly. Competition and monopoly lie at opposite ends of the market spectrum. Perfect competition and monopoly are rarely found in the real world and thus they do not represent the actual market situation.
- 1 What is Monopolistic Competition?
- 2 Characteristics of Monopolistic Competition
- 3 Features of Monopolistic Competition
- 4 Equilibrium Under Monopolistic Competition
Still, for many years economists believed that either the competitive or the monopoly model could be used to analyse most markets.
Nature of the Demand Curve of Monopolistic Competition
The demand curve of the monopolistic competition has the following characteristics:
Less than Perfectly Elastic
In monopolistic competition, no single firm dominates the industry and due to product differentiation, the product of each firm seems to be a close substitute, though not a perfect substitute for the products of the competitors. Due to this, the firm in question has a high elasticity of demand.
Demand Curve Slopes Downward
In monopolistic competition, the demand curve facing the firm slopes downward due to the varied tastes and preferences of consumers attached to the products of specific sellers. This implies that the demand curve is not perfectly elastic.
Characteristics of Monopolistic Competition
Following are the main characteristics of Monopolistic Competition:
- Product Differentiation
- Freedom of Entry and Exit of Firms
- Selling Cost
- Price Control
- Limited Mobility
- Imperfect Knowledge
- Non Price Competition
Product differentiation is the main feature of monopolistic competition. Product differentiation means that products of different types, brands, and qualities will be available to customers in a fixed time period. Product differentiation occurs when the buyer of a product can differentiate between two products.
In this, firms are in large number but their products are different from each other in any way, but these products are close substitutes of each other.
Product differentiation is obtained due to characteristics of a product like a shape, measurement, colour, durability, quality etc. There are many examples of product differentiation like bath soaps Lux, Godrej, Camay, Rexona, etc.
Freedom of Entry and Exit of Firms
In the situation of monopolistic competition, there is freedom of entry and exit of firms in the industry like perfect competition. It should be noticed that Chamberlin has used group at the place of the industry for a group of firms that produce differentiated products under the monopolistic competition.
An important characteristic of monopolistic competition is that every firm spends more money in promoting its product under it. The firm gives advertisements in newspapers, cinemas, magazines, radio, T.V. etc. for selling its product in the maximum amount. The investment done on all these is called Selling Costs.
Every firm has limited control over the cost of a product. The average income and limit end income curve of a firm fall down like a monopoly in monopolistic competition. It means that in this situation, the firm can slow down the price for selling more products and raise the price for fewer products.
In monopolistic competition, a firm has control over the cost of its production due to product differentiation. But due to the availability of close substitutes of opposite products firms do not have full control over cost in monopolistic competition.
The cost of every firm is affected by the cost policy of its competitors in the market up to a certain limit.
In monopolistic competition, sources of production and products and do not have mobility in services.
In the situation of monopolistic competition, buyers, sellers of products, and owners of sources do not have knowledge of different prices of products. The reason is that comparison between productions of different firms is not possible due to product differentiation.
Customers are fond of the production of any one specific firm. They only buy the production of that firm even if it costs higher than others. In this way, even sources of production are not able to know fully that how much the different firms are costing to the sources of services.
Non Price Competition
The main characteristic of monopolistic competition is that under it different firms without changing the costs of products compete with each other like the example of companies producing ‘Surf’ and ‘Ariel’. If you take a box of ‘Surf’, you will get a glass utensil similarly, with the box of ‘Ariel’ you will get the steel spoon.
In this way, firms, by providing different types of facilities and products etc. to customers to attracts them toward their products. This type of competition is called a Non-Price Competition.
Features of Monopolistic Competition
The following are important features of monopolistic competition:
- Large Number of Sellers
- Product Differentiation
- Non Price Competition
- Freedom of Entry and Exit
- Perfect Knowledge About Market and Technology
- Uniform Price
Large Number of Sellers
The market consists of a relatively large number of sellers or firms each satisfying a small share of the market demand for the commodity. Unlike perfect competition, these large numbers of firms do not produce homogeneous products.
Product differentiation is a key feature of monopolistic competition. Product differentiation is a situation in which firms use a number of devices to distinguish their products from those of other firms in the same industry. Products produced by the firms are close substitutes for each other. Products are not identical but are slightly different from each other.
In the case of monopoly, there is only one product and only one seller, and under perfect competition, a large number of sellers sell homogeneous products. But under monopolistic competition, the firms can differentiate their products from one another in respect of their shape, size, colour, design, packaging, etc.
Products of individual firms are generally identifiable, even though they may be very similar to the products of other firms. Product differentiation may be real or it may be based on perceived differences by consumers.
Non Price Competition
Firms incur considerable expenditure on advertisement and other selling costs to promote the sales of their products. Promoting sales of their products through advertisement is an important example of non-price competition.
The expenditure incurred on advertisement is prominent among the various types of selling costs. But Chamberlin defines selling costs as “cost incurred in order to alter the position or the shape of the demand curve for a product”.
Thus his concept of selling cost is not exactly the same as advertisement cost. Selling cost is the advertisement cost plus expenditure on sales promotion schemes, salary and commission paid to sales personal, allowance to retailers for displays and cost of after-sale services.
Freedom of Entry and Exit
In a monopolistically competitive industry, it is easy for new firms to enter and the existing firms to leave it. As in the case of perfect competition, there is no barrier to the entry of new firms and the exit of old ones from the industry.
Firms will enter into the industry attracted by supernormal profit of existing firms and existing firms will leave the industry if they are making losses. The entry of new firms reduces the market share of the existing ones and the exit of firms does the opposite.
These consequences of free entry and exit lead to intense competition among the firms for both retaining and increasing their market share.
Perfect Knowledge About Market and Technology
There is the absence of perfect knowledge. That is buyers and sellers do not have perfect knowledge about market conditions. All firms have complete information about the market and technologies available for producing the product.
It ensures that all the firms in the industry have the same cost structure. No firm enjoys an additional competitive advantage on account of lower cost.
There is no uniform price. Different producers charge different prices for their products because products are differentiated in some way.
Equilibrium Under Monopolistic Competition
In the situation of monopolistic competition, if any firm wants to sell the maximum quantity of its production then it has to decrease the cost. That’s why, in the situation of monopolistic competition, the Average Revenue Curve (AR Curve) and Marginal Revenue (MR Curve) fall down in the form of left to right.
In monopolistic competition, a firm produces till the point or limit at which
- Marginal Revenue is equal to Marginal Cost (MR = MC)
- Marginal Revenue Curve cuts Marginal Cost Curve from the lower side. In this situation firm is in the condition of balancing by the production.
The study of equilibrium firms in monopolistic competition can be done in two different durations:
Short Run Equilibrium in Monopolistic Competition
Short Run is the duration of time in which production can be increased only by the increase in using variable resources on increasing demand. There is no time to increase or decrease constant resources of production like machines, plants, buildings, etc.
In the short run, an equilibrium of a firm will be in that situation in which (1) MC = MR and (2) MC curve will be cutting MR curve.
There can be three conditions of firms in this duration of time:
Super Normal Profits
The firm is in equilibrium at point E because the marginal cost and marginal revenue are equal (MR = MC) on point E and the MC curve cut the MR curve from the lower side. It is known by point E that OM will be the equilibrium production of the firm.
The cost of equilibrium production is OC (= AM). The cost (AM) of equilibrium production will be less (AM ˂ BM) than average Revenue BM so every unit of the firm is obtained Super Normal Profits BM – AM = AB. The firm has total super normal profit ABCP.
In the short run, firms of monopolistic competition can have normal profits. the firm will be in an equilibrium situation at point E because at point E (i) MC = MR and (ii) MC curve cut MR from the lower side. It is known by point E that OM will be the equilibrium production.
The cost of equilibrium production is OP (AM) and the average cost is also OP (AM). The reason is that the AR curve is touching the AC curve at point A. That’s why in the situation of equilibrium cost (AR) and average cost (AC) are equal (AR = AC). Therefore, only normal profits will obtain from the firm.
The firm can also have a loss of fixed cost in short-run. This is the minimum loss of the firm. The firm will be in equilibrium at point E. At this point, MC = MR and MC curve cut MR curve from the lower side. In the equilibrium condition, the firm will produce OM.
The cost of equilibrium quantity OM is OP (= BM) and the average cost is OP1 (= NM). A short-run average cost of the firm is more than (SAC > AR). So the firm will have a per unit loss of NM – BM = BN. Total loss of firm will be the area of NBPP1.
Long Run Equilibrium in Monopolistic Competition
Long-term is the duration of time in which firms can change the level of their plants, new firms can enter into the market and old firms can leave the market. It should be kept in mind that products differentiated in monopolistic competition are not similar.
Chamberlin had used the word product group at the place of industry to those firms which produce the differentiated products.
In Figure, LAC is the long-run average cost curve and LMC is the long-run marginal curve. AR is lead average and MR is a marginal lead curve. MR and MC at point E are equal to each other. Therefore, it will be an equilibrium point.
OM will be produced on this point, which costs OP(=AM). The average revenue curve on equilibrium production OM is touching the long-run average cost curve at point A. So, in the equilibrium condition, cost and long-run average cost (AR = LAC) are equal to each other.
Therefore, firms are earning only normal profits. There will be maximum profits of LAC and AR at ‘A’, Point of Tangency. The reason is that on any other cost average cost (AC) is more than the average revenue (AR) of the long-run average cost curve (AR) so the firm will incur a loss.
Due to the normal profits obtained by the firm, there will be no encouragement for the entry of new firms in the group and no reason for the exit of old firms from the group.