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Monopolistic Competition

Monopolistic Competition


It is a cardinal fact that the potential of any firm to earn long-run profits and to take any important decision, is directly dependent on the market structure in which it operates. The market can be divided mainly into two major categories – perfect competitive market and imperfect market. The imperfect market structure can further be segmented into monopoly, duopoly, oligopoly and monopolistic markets. However, in the modern era, the monopoly and perfect competition, being two extreme forms of market competition, have ceases to exist.

In the year 1932, E.H. Chamberlin and J. Robinson proposed the concept of a new type of market competition which is a combination of features from perfect competition and monopoly and is termed as monopolistic competition. The theory of monopolistic competition provided a more realistic explanation of actual market structure prevailing in the practical world. The theory suggests that in every market structure, each producer resembles the characteristics of monopolists – but within these natural monopolists, there is an existence of perfect competition. Thus, monopolistic competition can be defined as a market situation that resembles perfect competition in most respects, except for the presence of product differentiation. If this product differentiation is extremely successful, all the producers become virtually monopolists in their differentiated product markets.


Principal Characteristics

The monopolistic competition is characterized by certain inherent features as follows:
1. Large number of sellers
2. Free entry and exit of firms in the market
3. Advertizing
4. Product differentiation


Large number of sellers: Like a pure competitive market, a monopolistically competitive market is characterized by the existence of many sellers, although the number is not as large as that in the case of the former. Hence, in a monopolistically competitive market, there exist a large number of firms each one being independent to one another. Each firm’s market share is so small that its actions hardly create any reaction among its competitors.

Free entry and exit in the market: In a monopolistically competitive market, the barriers to entry and exit are low but not absolutely free. Due to certain product differentiation, the long-established firms generally possess loyal customers who are often unwilling to switch over to a new product. Similarly, exit from one industry to another can be a difficult task for the firms in a monopolistically competitive market because, it can affect their long-established customer's acceptance which are always difficult to regain.

Advertizing: In monopolistically competitive markets, along with severe price-competition, there exists a huge non-price-competition between the firms. Advertising is a technique of demand manipulation. Firms advertise in an attempt to shift customers demand curves for their products to the right. This implies that they can sell more at the same price.
Firms also advertize to make the demand curves for their products more elastic. This means that the consumers become less responsive to the price increase.

Product Differentiation: the most important feature of monopolistic competition is product differentiation. It means that basically similar products are changed in the some way to create some differences among them, at least in the eyes of the customers.


The above figure shows the demand curves of firms A and B. consumers view firm A's product as being slightly differentiated from the bulk of the industry's output and hence firm A is close to being a price-taker. On the other hand, firm B has successfully differentiated its products, and consumers are, therefore, less willing to seek substitutes for B's output. Accordingly, B's demand is not sensitive to changes in price.

A product differentiation can be of two types – real or fancied. The differentiation is said to be fancied when the products varies from one other in terms of packaging, trademarks, logos etc. A real differentiation, on the other hand, takes place when the products are differentiated in terms of qualities, specifications, features and after sales services. The basic intention of product differentiation is to remove the perfect elasticity of the firm's demand curve. Instead of being price-takers facing horizontal demand curve, the firm determines its optimal price/output combination. The degree of price flexibility depends on the strength of a firm's product differentiation. Strong differentiation results in greater consumer loyalty, thereby, gaining more control over the price. In other words, the more differentiated a firm's product, the lower the substitutability of other products for it.




REFERENCES

Elmer, G. W. Imperfect Competition Models, Monopolistic Competition, Egwald Economics,
12 April, 2007, http://www.egwald.com/economics/monopolistic1.php

Monopolistic Competition, Windward Community College, University of Hawaii,
http://www.wcc.hawaii.edu/facstaff/briggs-p/Microeconomics/Chap_17.pdf

Steven M. S. Monopolistic Competition, International Trade Theory and Policy, 15 February,
2007, http://internationalecon.com/Trade/Tch80/T80-5.php

Valentino, P. Product Differentiation, Economics Web Institute, 2003,
http://www.economicswebinstitute.org/glossary/product.htm

Posted by: Jeffrey M.

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