MONOPOLISTIC COMPETITION

Monopolistic competition is 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.  Still  for  many  years economist believed that either the competitive or the monopoly model could be used to analyse most markets. In 1933, Edward Chamberlin challenged this belief when he published  The Theory  of Monopolistic  Competition.  Because  his model  of monopolistic competition  seemed to describe many real world markets better than the competitive model did, it was enthusiastically  received by most economists. In the same year, Joan Robinson published The Economics of Imperfect Competition. The similarity in the subject matter and in some of the techniques led to the judgments that the analyses in the two books were the same.

The Nature of Monopolistic Competition

As the name  implies,  monopolistic  competition  contains  the element  of both  pure competition and monopoly. The competitive element arises from the fact that there are many  sellers  of the  differentiated  product,  each  of which  is too  small  to affect  other sellers. Firms can also enter and leave the monopolistically competitive industry rather easily  in the  long  run.  The  monopolistic  element  arises  from  product  differentiation. That  is, since  the product  of each seller is similar  but not identical,  each seller  has a monopoly power over the specific product it sales. Thus, monopolistic competition may be defined as a market structure where there are many sellers who sell differentiated products which are close substitutes of one another. Each producer under monopolistic competition  enjoys some degree of monopoly and at the same time faces competition. Chamberlin  coined  the  term  monopolistic  competition  to  cover  all  market  situations lying between perfectly competitive markets and monopoly. Within this wide range, he further  distinguished  between  markets  where  there  are large numbers  of sellers of a differentiated product (the large group) and small numbers (the small group). The term monopolistic competition now generally used to refer to Chamberlin’s ‘large group’, with the small group being referred to as oligopoly.   The following are important features of monopolistic competition.

1.   Large number of sellers

The market consists of 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.  Instead  they produce and sell differentiated products which are close substitutes of each other. Thus there is stiff competition between them. Under perfect competition, the number of sellers is so

large that a firm becomes a price taker. In contrast under monopolistic competition, the number of firms is only so large that a firm retains its power to be a price maker.

2.   Product Differentiation

Product differentiation is a key feature of monopolistic competition. Product differentiation  is a situation in which firms use number of devices to distinguish  their products from those of other firms in the same industry. Products produced by the firms are close substitutes of each other. Products are not identical but are slightly different from each other. In case of monopoly, there is only one product and only one seller, and under  perfect  competition,  a  large  number  of  sellers  sell  homogeneous  product.  But under  monopolistic  competition,  the  firms  can  differentiate  their  products  from  one another   in  respect   of  their  shape,   size,  color,  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.

3.   Non price  competition: Selling cost

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 amoung 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.

4.   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 on the entry  of new  firms and exit of old ones from  the industry.  Firms will enter  in to the industry attracted by super normal profit of existing firms and existing firms will leave industry if they are making losses.   Entry of new firms reduces the market share of the existing ones and exit of firms does the opposite. These consequences of free entry and exit lead to intensive  competition  amoung the firms for both retaining  and increasing their market share. However entry may not be as easy as in perfect competition because of the need to differentiate one’s product in a monopolistically competitive market. Sometimes, it is possible for companies to create barriers to entry for potential rivals by using advertising and product differentiation. Advertising can create product awareness and loyalty to well known brands. Product differentiation can impose barriers to entry and increase the market power of producers.

5.   There is absence of perfect knowledge. That is buyers and sellers do not have perfect knowledge about market conditions

6.   There  is  no  uniform  price.  Different  producers  charge  different  prices  for  their products because products are differentiated in some way.