What is Monopolistic Competition?
Monopolistic Competition emerged as a concept when the theory of Perfect Competition and the theory of Monopoly failed to explain the existence of differentiated products in a competitive market set-up. Robinson and Chamberlin provide the theoretical foundation for Monopolistic Competition in the 1930s.
There are 9 important features or assumptions of Monopolistic Competition that we are going to discuss over this article –
- Large number of sellers and buyers : In a monopolistic competitive market there are relatively large number of firms having a small share of the market demand for the product. This type of market set up does not have elite sellers like oligopoly. However, the firms are not too small like a perfectly competitive seller who do not have any market price manipulating power.
- Economically and technologically substitutable yet differentiated products : Each firm enjoys some power over market price as their product offering has some sort of individuality. However, such power of the firm is limited to a small margin only as other firms are offering close substitutes. Hence, the perceived demand curve of each firm is downward sloping but with high price elasticity. The assured market size is small for each seller.
- Freedom of entry & exit : Firms don’t face any significant hurdle while entering or exiting the market. Fixed costs are not too high for this type of market. This along with price competitiveness ensures that in the long run each firm earns normal profit.
- Profit maximizing Producers : Each firm aims to maximize their profit in both the short run and long run and hence, each firm selects to produce at the level of output which makes the marginal revenue from that equal to the marginal cost of producing it.
- Influence over market price : Under Monopolistic competition each firm is not a price taker but has some influence over the price of their product. Since each firm under monopolistic competition produces a slightly differentiated product, if they lower their price, some customers over other products will prefer to buy their product and vice versa.
- Selling Cost : Under Monopolistic Competition firms incur a considerable amount of expenditure on advertisement and other selling costs to promote the sales of their products. Selling costs bridge the gap between the qualities of the seller’s products and the buyer’s necessary information.
- Certainty about Demand and Cost : Each individual firm knows its demand and cost conditions with certainty.
- Classical Cost Curves : Cost curves are of usual or traditional shapes. Average cost and marginal cost curves are downward sloping for initial output levels and then upward rising for later stages of production level. Marginal cost curve cuts the average cost curve at its minimum point.
- Given factor prices and technology : Firms do not face personal competition from factor owners and do not enjoy any monopsonistic power either.