Monopolistic Competition

Definition:
Monopolistic competition as a market structure was first identified in the 1930s by American
economist Edward Chamberlin, and English economist Joan Robinson. Monopolistic/Imperfect
competition as the name signifies is a blend of monopoly and competition.
According to Leftwitch:
"Monopolistic competition is a market situation in which there are many sellers of a particular
product, but the product of each seller is in some way differentiated in the minds of consumers
from the product of every other seller".
In the words of J.S. Bain:
"Monopolistic competition is found in the industry where there is a large number of small sellers
selling differentiated but close substitute products".

Characteristics of Monopolistic Competition:

(i) A fairly large number of sellers: The number of firms in monopolistic competition is fairly
large.
(ii) Differentiation in products: Under monopolistic competition, the firms sell differentiated
products. Product differentiation may be real or imaginary. Real differentiation is done
through differences in the materials used, design, color etc. Imaginary differences may be created
through advertisement, brand name, trademarks etc.
(iii) Freedom of entry and exit of firms: The entry of new firms in the monopolistically
competition industry is relatively easy. There are no barriers of the new firm to enter the product
group or leave the industry in the long run.
(iv) Nature of demand curve: Since the existence of close substitutes limits the monopoly power,
the demand curve faced by a monopolistically competitive firm is fairly elastic. If the number of
firms is fairly large and the product of each firm is not very similar, the demand curve of a firm will
be quite elastic. In case, there is close competition among the rival firms for the sale of similar
products, the demand curve of a firm will be less elastic.
(v) Advertisement and propaganda: Each firm tries to create difference in its product from the
other by advertising, propaganda, attractive packing, nice smile, etc.
(vi) Sales efforts: With heterogeneous products, the sale of the products by the firms can no
longer be taken for granted sale depends upon sale efforts.
(vii) Non-price competition: In monopolistic competition, the firms make every effort to win over
the customers. Other than price cutting, the firms may offer after sale service, a gift scheme,
discount not declared in the price list etc.

The advantages of monopolistic competition

Monopolistic competition can bring the following advantages:
1.
2.
3.

There are no significant barriers to entry; therefore markets are relatively contestable.
Differentiation creates diversity, choice and utility. For example, a typical high street in any
town will have a number of different restaurants from which to choose.
The market is more efficient than monopoly but less efficient than perfect competition - less
allocatively and less productively efficient. However, they may be dynamically efficient,
innovative in terms of new production processes or new products. For example, retailers
often constantly have to develop new ways to attract and retain local custom.

The disadvantages of monopolistic competition

There are several potential disadvantages associated with monopolistic competition, including:
1.

2.

Some differentiation does not create utility but generates unnecessary waste, such as
excess packaging. Advertising may also be considered wasteful, though most is informative
rather than persuasive.
As the diagram illustrates, assuming profit maximization, there is allocative inefficiency in
both the long and short run. This is because price is above marginal cost in both cases. In
the long run the firm is less allocatively inefficient, but it is still inefficient.

SHORT RUN EQUILIBRIUM UNDER MONOPOLISTIC COMPETITION

A single firm in the product group (industry) has little impact on the market price. However, if it
reduces price, it can expect a considerable increase in its sales. The firm may also attract buyers
away from other firms by creating imaginary or real difference through advertising, branding and
through many other sales promotion measures (non-price competition). If the firm raises its price,
it will not lose all its customers. This is because of the fact that the product is differentiated from
competing firms due to price and non-price factors. The demand curve (AR curve) of the
monopolistic firm is therefore, highly elastic and is downward sloping. As regards the marginal
revenue curve, it slopes downward and lies below the demand curve because price is lowered of
all the units to sell more output in the market.

Short Run Equilibrium

The short-run equilibrium in Monopolistic competition market structure can be explained with the
help of two approaches.
1. Marginal revenue = marginal cost approach or (MR = MC) rule.
2. Total revenue Total cost approach or TR-TC=Maximum Profit
1. Marginal revenue = Marginal cost approach or (MR = MC) rule.
According to the marginal revenue and marginal cost approach, maximum profits are obtained at
the output level where marginal revenue equals marginal cost. Thus in the given figure, panel (a),
the most profitable output level is at q* units, where the marginal cost (MC) curve intersects the
marginal revenue (MR) curve.
2. Total revenue Total cost approach or TC-TC=Maximum Profit
According to the total revenue and total cost approach, total profits are maximized at the output
level where total revenue (TR) exceeds total cost (TC) by the greatest amount. Thus in the given
figure, panel (b), the firms profit is maximum at an output of q* units, where the vertical distance
between TR and TC is greatest.
Summing up, profit maximization normally occurs at the rate of output at which marginal revenue
equals marginal cost. This golden rule holds good for all market structures. In the given figure,
panel (c), total profit is maximum at the output level q*.

P
MR
MC

(a)
MC

D, AR

MR=MC

q*

MR

TC
TR
TC

(b)

Maximum
Economic
Profit
TR

q*

P
r
o
f
i
t

Maximum
Economic
Profit

(c)

(+)
O

q*

(-)
(The profit Maximizing Price and Output of a Monopolistic competitive Firm under Short Run)