Analysis of Market

Monopolistic Competition

In a Monopolistic Competition, each seller produces a differentiated product which is easily distinguishable from its close substitutes. In this article, we will look at what is Monopolistic Competition and its features in detail.

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What is Monopolistic Competition?

Prof. Leftwitch’s answer to what is Monopolistic Competition:

‘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.’

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Prof. H.H. Liebhafsky’s answer to what is Monopolistic Competition:

Monopolistic competition has today come to mean a state of affairs in which there is a large number of sellers selling non-homogenous or slightly differentiated products and in which freedom of entry exists.

what is monopolistic Competition

                                                                                                                                     Source: Wikipedia

Therefore, in this market structure, each seller is a monopolist of his ‘differentiated product’. The buyers can get the specific product only from him. Having said that, there are several close substitutes available in the market too.

Therefore, buyers compare the prices of the products along with the perceived quality of each. Hence, there is competition between sellers for the market share. So you can see that in this market structure, a group of firms compete against each other while remaining monopolists of their own products.

Unfortunately, we cannot define a Monopolistic Competition in detail due to the following problems:

  • The products are not homogeneous. Therefore, it is impossible to determine the market demand for the product precisely. In fact, it is difficult to determine the average revenue curve of the industry as well.
  • Since the firms are not providing the same product, defining an industry becomes complex too. The best definition is a group of firms who sell products which are close substitutes of each other.
  • It is also difficult to define a ‘group’ since the product group under consideration is competing with other product groups too!

Now that you have a better idea about what is Monopolistic Competition, let’s take a look at its features.

Features of a Monopolistic Competition

  1. In Monopolistic Competition, a buyer can get a specific type of product only from one producer. In other words, there is product differentiation.
  2. The firms have to incur selling expenses since there is product differentiation.
  3. There is a large number of sellers with inter-dependent demand and supply conditions. Sellers are price-makers and the demand curve for the product of an individual seller is downward sloping. The demand is not perfectly elastic.
  4. The firm can improve or deteriorate the quality of its products too. Improving the quality helps in increasing the demand and price of the product. On the other hand, deteriorating the quality helps reduce the average cost of production.
  5.  The firms compete for inputs too. Also, they need to operate within a given technological range. Therefore, no firm can produce a better quality product at a lower average cost.
  6. Firms are expected to know its demand and cost conditions. Further, they must use this knowledge to maximize its expected profit income.
  7. Any firm can leave the group of firms belonging to a specific product group. Also, new firms can enter the group and produce close substitutes of the existing products in the group. This ensures that no firm incurs losses or earns super-normal profits.
  8. In Monopolistic Competition, every firm must pursue the goal of profit maximization.
  9. It is assumed that all firms in this market structure have identical cost and demand conditions.

Two features which form the foundation of Monopolistic Competition are – product differentiation and selling expenses. Let’s look at them a little further.

Product Differentiation

Product differentiation covers all aspects which help in distinguishing the product of one firm from that of the other. This differentiation can be real (technical) or imaginary (non-technical).

The real differentiation refers to the technical features like the product’s technical life and performance, durability, cost of operation and maintenance, etc.

On the other hand, the non-technical differentiation may take the form of brand names, trademark, packing, shape, size, etc. The non-technical differentiation adds a subjective appeal to a product inducing buyers to increase its demand or pay more for it.

In reality, however, the two forms of differentiation are intertwined to the extent that it is impossible to separate them. No matter which differentiation a firm adopts, it expects to increase the demand of the product in doing so.

Firms use the differentiation to tell buyers why their product’s quality and price combination is better than their competitors.

In Monopolistic Competition, a firm is not a price-taker and its demand curve has an inverse relationship with the price of the product.

Therefore, it can raise the price of its product and lose some customers or drop the price to sell more. The demand curve is downward sloping and not parallel to the X-axis.

Since in Monopolistic Competition, products are close substitutes of each other, they have high positive cross-elasticities.

The market for the product of one firm is not separate from the markets of its rival firms. A firm can lose the market share of its products due to its price decisions or the price decisions of its rivals.

Further, selling expenses also play a major role in determining the demand conditions for the product of a firm.

Selling Expenses

Selling expenses are all the costs that a firm incurs to create and/or increase the demand for its products. The firm tries to shift the demand curve of the advertised product to the right so that buyers are willing to pay more for the same quantity or buy more quantity at the same price.

They include advertisement through media, showrooms, selling campaigns, discounts, and incentives to buyers, etc.

They also include informative and educative campaigns where the buyer is informed about the benefits of using their product over something else.

These expenses also neutralize the perceived impact that the selling campaigns of the rival companies create. Many firms increase their selling expenses to capture a bigger market share as well.

Solved Question on Monopolistic Competition

Q1. What is Monopolistic Competition and what are its two main features?

Answer: In a Monopolistic Competition, each seller produces a differentiated product which is easily distinguishable from its close substitutes. The two main features of Monopolistic Competition are product differentiation and selling expenses.

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