Monopolistic competition describes a scenario where many firms compete by selling products that are differentiated from one other and hence are not perfect substitutes. Product differentiation may be due to the brand, product quality, location, or marketing strategy. Monopolistic competition describes an industry where many firms offer products or services that are similar (but not perfect) substitutes.
Understanding monopolistic competition
Monopolistic competition combines elements of a monopoly and perfect competition – a theoretical market state in which companies sell identical products and have equal market share. The term was first used by economists Edward Chamberlain and Joan Robinson in the 1930s to explain the competition that existed between firms with similar (but not identical) products.
Firms that are in monopolistic competition have a comparable and relatively low degree of market power. They are said to be price makers, or companies that can dictate the price they charge for goods because there are no perfect substitutes in the market. Importantly, prices can be lowered without inciting a price war which is a common problem in oligopolies.
As more firms enter a monopolistic market, the elasticity of the demand curve increases. This means consumers become more sensitive to price, with a small price increase causing demand for a product to vanish. Profit in the short term is positive, but over the long term, it approaches zero as marginal revenue equals marginal cost.
Characteristics of monopolistic competition
To summarise and expand upon the information presented above, consider the following characteristics of monopolistic competition:
- The presence of many firms and many consumers, with no firm having total control over the marketplace.
- Few barriers to entry or exit. This means the market is dynamic as companies can easily enter or exit the market at their discretion.
- Differentiated but similar products and services. Consumers perceive there to be differences between products that are not based on price.
- Firms operate independently. That is, they operate with the knowledge that their actions will not affect the actions of other firms.
- Potential supernormal profits in the short term. One firm can profit from identifying a gap in the market until competing firms move in and offer similar products.
- Normal profits in the long run. Due to low barriers of entry, a new firm may see an existing firm make supernormal profits and enter the market to take their share. As competitors flock to an untapped market segment, profits are reduced to zero over time.
- Imperfect information – with many firms offering slightly different products, a consumer may find it more difficult to make a purchasing decision. In the insurance industry, for example, several comparison sites now exist to help consumers understand the sometimes vague but important distinctions between products.
Examples of monopolistic competition
Monopolistic competition is present in many familiar industries. Examples include:
Clothing and apparel
Clothing items are inherently similar because each is designed for the same purpose. Brand and style differentiation is common in this industry.
Which compete on food quality and customer service. Among Indian restaurants, for example, product differentiation is key since each offers more or less the same regional dishes. What’s more, there are also relatively few barriers to opening a new restaurant.
The accommodation industry is also characterized by many firms offering the same service. Each provider differentiates itself with minor variations in quality level or access to perks.
Like most retail or food and beverage outlets, there are countless coffee shops around the world selling the same product. Product differentiation occurs via the quality of the coffee beans and the level of customer service. These establishments may also offer Wi-Fi or be located within bookstores to stand out.
- Monopolistic competition describes an industry where many firms offer products or services that are similar (but not perfect) substitutes. The term was first used by economists Edward Chamberlain and Joan Robinson in the 1930s.
- Monopolistic competition has many characteristics, including the presence of many firms and consumers, low entry and exit barriers, short-term supernormal profits, long-term normal profits, and imperfect information.
- Monopolistic competition is present in many familiar industries, including clothing and apparel, restaurants, accommodation, hairdressing, and coffee shops.
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