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What Is Monopolistic Competition: Definition, Features, Examples, Diagrams

Monopolistic competition is the closest to a perfect competition market.

What Is Monopolistic Competition Market: Definition

Monopolistic competition is a type of industry market in which many enterprises sell differentiated products (unique in their industry and have some qualities that consumers value), as well as exercise control over the price of the goods they produce.

The term “monopolistic competition” and the description of this market model were introduced by Edward Hastings Chamberlain in his work “The Theory of Monopolistic Competition” in 1933.

Read post “What Is Oligopoly Market: Definition, Characteristics, Types, Barriers to Enter.”

What Industry Is an Example of Monopolistic Competition?

The model of monopolistic competition is more common in industries that provide services, for example, retail trade, private practice of lawyers, doctors, hairdressing, cosmetology services, etc.

As for material goods, it would be correct to say that the wholesale production of, for example, washing powders, drinks, and sweets belong to the oligopoly, but the retail market to monopolistic competition.

Read post “What Is Microeconomics and What Does It Study: Main Topics, and Theories.”

Examples of monopolistic competition:

  • Dairy market.
  • Production of confectionery.
  • Clothing market.
  • Furniture market.
  • The market for luxury goods.
  • Glossy magazines.
  • Restaurant business.
  • Petrol stations.
  • Building organizations.

What is a Market of Monopolistic Competition in Simple Words

In conditions of monopolistic competition, each manufacturer produces its product, and all together produces goods of the same group. Accordingly, these products are not identical: each of them differs in packaging, design, quality, trademark, after-sales service, and price.

In some sense, each of the producers is considered a monopolist, because, due to product differentiation, he is the only producer of his product.

At the same time, there is competition, since there are similar, although not completely interchangeable products. If the consumer’s favorite product is inferior in price and quality to the competitor’s product, then his choice will be obvious: he will buy something cheaper and/or better.

Based on this, the monopolistic competition market is perfect competition plus product differentiation.

Features of Monopolistic Competition

Features and characteristics of monopolistic competition market
Features and characteristics of monopolistic competition market

The main features of monopolistic competition are:

  1. The relatively large number of sellers on the market, each of which satisfies an insignificant part of the market demand.
  2. Because each seller has a relatively small market share, their control over the market price is limited.
  3. Product differentiation. The product of each firm is not a perfect substitute for the product sold by other firms. Each firm’s product has exceptional features or characteristics that give it an advantage over its competitors.

Differentiation can be based on real or imaginary differences.

Real differences:

  • product quality,
  • placement and availability,
  • services and conditions related to the sale,
  • sales equilibrium incentives.

Imaginary differences:

  • differences created through advertising,
  • using well-known brands,
  • company image.

4. Sellers set prices for their products and a certain amount of sales without taking into account the reaction of their competitors.

5. There are opportunities for free entry and exit in the market. However, the conditions are more complex than in free competition, because adequate capital is required. In addition, if a firm uses different technologies, this affects how quickly buyers recognize a new brand.

6. Consumers are guided by price and non-price differences between goods.

Output and Price (Diagrams): Demand Curve and Marginal Revenue Curve

In the monopolistic competition market, the manufacturer has the opportunity to reduce the elasticity of his product by improving its quality and by increasing the cost of its sale, primarily advertising. By improving the quality and active advertising campaign, the company gets additional opportunities to increase the price, and, consequently, increase its profits.

The elasticity of the demand curve for a firm operating under monopolistic competition depends on the number of competitors and the degree of differentiation of manufactured products.

The more competitors and less product differentiation, the more elastic the demand curve will be. The closer the situation is to the conditions of free competition.

The less competition and more product differentiation, the more the demand curve approaches the curve of monopoly production.

The demand curve for a monopolistic competitor is downward with a slight slope:

Demand curve in monopolistic market
The demand curve for monopolistic competition

where d is the demand curve.

Ceteris paribus, the more competitors and less product differentiation, the higher the price elasticity of demand for the products of an individual firm.

A large number of producers excludes the possibility of collusion and concerted action between firms to limit output and raise prices and does not allow the firm to significantly influence market prices.

Under monopolistic competition, the marginal revenue curve (MR) is below the demand curve (D), and its slope will be half the slope of the demand line:

Marginal revenue curve MR and demand curve D
Marginal revenue curve MR and demand curve D under monopolistic competition

How Does the Firm Function in the Short Run Under Monopolistic Competition

In figure a, the firm maximizes profit, in figure b it minimizes losses:

Profits and losses of a firm in the short run in a monopolistic competition market
Profits and losses of a firm in the short run in a monopolistic competition market

Because the demand for a product is not perfectly elastic, the marginal revenue curve runs below the demand curve.

In the short run, the firm maximizes profits or minimizes losses by producing the output that corresponds to the coordinates of the intersection point of the marginal cost and marginal revenue curves.

The firm will receive the greatest profit at the price Po and output Qo, and the minimum loss at the price P1 and output Q1.

Equilibrium Under Monopolistic Competition

The economic profit that a firm earns under monopolistic competition encourages new firms to enter the industry.

The increase in the number of competitors leads to the fact that the demand curve becomes more elastic, bringing the conditions of monopolistic competition closer to the conditions of a competitive market. The distance between demand curves and average costs decreases.

If the company suffers losses, then there is an outflow of competitors, and the demand curve becomes steeper (less elastic).

Thus, in the long run, an equilibrium is established when the curves of demand and average costs have only one common point, i.e. when the price is set at the level of average costs for a certain volume of output.

Setting the price at the average cost level is only a trend.

Equilibrium under monopolistic competition
Equilibrium under monopolistic competition

Non-Price Competition

There is significant non-price competition in the monopolistic market.

The main methods of non-price competition are:

  1. Methods related to product improvement.
  2. Methods focused on advertising and promotion.

The goal of advertising is to increase the share of the company’s products in the market with the conditions of consumer loyalty to the company’s product.

Proponents of advertising believe that:

  1. Advertising helps the buyer to make a smart choice.
  2. Supports national communication systems.
  3. Accelerates product development.
  4. Allows firms to achieve economies of scale.
  5. Stimulates competition.
  6. Encourages spending and high levels of employment.

In opposition to proponents, critics of the advertising argue that:

  1. It does not inform the buyer but convinces him.
  2. Irrational moves resources away from more important areas of application.
  3. Induces some external costs.
  4. Leads to higher costs and prices.
  5. It encourages monopoly.
  6. Not a strategic cost and employment determinant.

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