by Monopolistic Competition is a form of market structure in which a large number of firms sell similar but not identical products. Each firm tries to differentiate its product through branding, quality, packaging, or advertisement. Due to product differentiation, firms have some control over price. Entry and exit of firms are relatively easy. Examples in India include restaurants, clothing brands, and cosmetics. Monopolistic competition combines features of both monopoly and perfect competition. It is important to study this market form to understand pricing, competition, and role of advertising in modern markets.
Characteristics of Monopolistic Competition:
1. Large Number of Sellers
Under monopolistic competition, there are a large number of sellers in the market. Each firm produces and sells a small share of the total market output. No single firm can control the entire market. In India, markets like clothing, footwear, and restaurants have many sellers. Due to large number of firms, competition exists, but each firm operates independently. This feature ensures freedom of entry and exit and prevents dominance by any one firm.
2. Product Differentiation
Product differentiation is the main feature of monopolistic competition. Firms sell products that are similar but not identical. Differentiation may be based on quality, brand name, design, packaging, or services. In India, soap brands like Lux, Pears, and Dove are examples. Due to differentiation, each firm has some control over price and enjoys brand loyalty. This feature creates non price competition through advertising and promotion.
3. Freedom of Entry and Exit
There is free entry and exit of firms in monopolistic competition. New firms can enter the market if they see profit opportunities, and existing firms can leave if they incur losses. In India, small shops and service providers can easily enter or exit the market. This feature ensures that in the long run, firms earn only normal profit and prevents long term super normal profit.
4. Selling Cost
Selling cost is an important characteristic of monopolistic competition. Firms spend heavily on advertisement, sales promotion, and packaging to differentiate their products and attract consumers. In India, companies spend large amounts on TV and online advertising. Selling cost increases demand for a firm’s product but also increases cost of production. This feature leads to brand competition rather than price competition.
5. Price Making Firm
Under monopolistic competition, each firm is a price maker to some extent. Due to product differentiation, a firm can slightly increase or decrease price without losing all customers. However, it cannot fix very high prices because close substitutes are available. In Indian markets, branded products enjoy some price control due to consumer loyalty. This feature gives firms limited monopoly power.
6. Non Price Competition
Non price competition is common in monopolistic competition. Firms compete through advertisement, better quality, attractive packaging, and after sales services rather than price reduction. In India, firms use discounts, offers, and branding to attract customers. This feature increases consumer choice but also increases cost due to heavy advertising.
Price Determination of Firm and industry under Monopolistic Competition:
In Monopolistic competition, since the product is differentiated between firms, each firm does not have a perfectly elastic demand for its products. In such a market, all firms determine the price of their own products. Therefore, it faces a downward sloping demand curve. Overall, we can say that the elasticity of demand increases as the differentiation between products decreases.
Fig. 1 above depicts a firm facing a downward sloping, but flat demand curve. It also has a U-shaped short-run cost curve.
Conditions for the Equilibrium of an Individual Firm:
The conditions for price-output determination and equilibrium of an individual firm are as follows:
- MC = MR
- The MC curve cuts the MR curve from below.
In Fig. 1, we can see that the MC curve cuts the MR curve at point E. At this point,
- Equilibrium price = OP and
- Equilibrium output = OQ
Now, since the per unit cost is BQ, we have
- Per unit super-normal profit (price-cost) = AB or PC.
- Total super-normal profit = APCB
The following figure depicts a firm earning losses in the short-run.
From Fig. 2, we can see that the per unit cost is higher than the price of the firm. Therefore,
- AQ > OP (or BQ)
- Loss per unit = AQ – BQ = AB
- Total losses = ACPB
Long-run Equilibrium:
If firms in a monopolistic competition earn super-normal profits in the short-run, then new firms will have an incentive to enter the industry. As these firms enter, the profits per firm decrease as the total demand gets shared between a larger number of firms. This continues until all firms earn only normal profits. Therefore, in the long-run, firms, in such a market, earn only normal profits.
As we can see in Fig. 3 above, the average revenue (AR) curve touches the average cost (ATC) curve at point X. This corresponds to quantity Q1 and price P1. Now, at equilibrium (MC = MR), all super-normal profits are zero since the average revenue = average costs. Therefore, all firms earn zero super-normal profits or earn only normal profits.
It is important to note that in the long-run, a firm is in an equilibrium position having excess capacity. In simple words, it produces a lower quantity than its full capacity. From Fig. 3 above, we can see that the firm can increase its output from Q1 to Q2 and reduce average costs. However, it does not do so because it reduces the average revenue more than the average costs. Hence, we can conclude that in monopolistic competition, firms do not operate optimally. There always exists an excess capacity of production with each firm.
In case of losses in the short-run, the firms making a loss will exit from the market. This continues until the remaining firms make normal profits only.
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