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7 Most Important Features of

Monopolistic Competition
by Smriti Chand Economics

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Some of the most important features of monopolistic competition are as


follows:
After examining the two extreme market structures, let us now focus our
attention to the market structure, which shares features of both perfect
competition and monopoly, i.e. “Monopolistic Competition”.
Image Courtesy : vschneider.edublogs.org/files/2011/11/Graph-Monopolistic-Competition-1l10y86.jpg

Monopolistic Competition refers to a market situation in which there are large


numbers of firms which sell closely related but differentiated products.
Markets of products like soap, toothpaste AC, etc. are examples of
monopolistic competition.

Monopoly + Competition = Monopolistic Competition


Under monopolistic competition, each firm is the sole producer of a particular
brand or “product”.

i. It enjoys ‘monopoly position’ as far as a particular brand is concerned.

ii. However, since the various brands are close substitutes, its monopoly
position is influenced due to stiff ‘competition’ from other firms.

So, monopolistic competition is a market structure, where there is competition


among a large number of monopolists.

Example of Monopolistic Competition: Toothpaste Market:


When you walk into a departmental store to buy toothpaste, you will find a
number of brands, like Pepsodent, Colgate, Neem, Babool, etc.

i. On one hand, the market for toothpaste seems to be full of competition, with
thousands of competing brands and freedom of entry.

ii. On the other hand, its market seems to be monopolistic, due to uniqueness
of each toothpaste and power to charge different price.

Such a market for toothpaste is a monopolistic competitive market.

Let us now discuss some of the important features of this kind of market.
Features of Monopolistic Competition:
1. Large Number of Sellers:
There are large numbers of firms selling closely related, but not homogeneous
products. Each firm acts independently and has a limited share of the market.
So, an individual firm has limited control over the market price. Large number
of firms leads to competition in the market.

2. Product Differentiation:
Each firm is in a position to exercise some degree of monopoly (in spite of
large number of sellers) through product differentiation. Product differentiation
refers to differentiating the products on the basis of brand, size, colour, shape,
etc. The product of a firm is close, but not perfect substitute of other firm.

Implication of ‘Product differentiation’ is that buyers of a product differentiate


between the same products produced by different firms. Therefore, they are
also willing to pay different prices for the same product produced by different
firms. This gives some monopoly power to an individual firm to influence
market price of its product.

Explore More about Product Differentiation:


1. The product of each individual firm is identified and distinguished from the
products of other firms due to product differentiation.

2. To differentiate the products, firms sell their products with different brand
names, like Lux, Dove, Lifebuoy, etc.

3. The differentiation among different competing products may be based on


either ‘real’ or ‘imaginary’ differences.
(i) Real Differences may be due to differences in shape, flavour, colour,
packing, after sale service, warranty period, etc.

(ii) Imaginary Differences mean differences which are not really obvious but
buyers are made to believe that such differences exist through selling costs
(advertising).

4. Product differentiation creates a monopoly position for a firm.

5. Higher degree of product differentiation (i.e. better brand image) makes


demand for the product less elastic and enables the firm to charge a price
higher than its competitor’s products. For example, Pepsodent is costlier than
Babool.

6. Some more examples of Product Differentiation:

(i) Toothpaste: Pepsodent, Colgate, Neem, Babool, etc.

(ii) Cycles: Atlas, Hero, Avon, etc.

(iii) Tea: Brooke Bond, Tata tea, Today tea, etc.

(iv) Soaps: Lux, Hamam, Lifebuoy, Pears, etc.

3. Selling costs:
Under monopolistic competition, products are differentiated and these
differences are made known to the buyers through selling costs. Selling costs
refer to the expenses incurred on marketing, sales promotion and adver-
tisement of the product. Such costs are incurred to persuade the buyers to
buy a particular brand of the product in preference to competitor’s brand. Due
to this reason, selling costs constitute a substantial part of the total cost under
monopolistic competition.

It must be noted that there are no selling costs in perfect competition as there
is perfect knowledge among buyers and sellers. Similarly, under monopoly,
selling costs are of small amount (only for informative purpose) as the firm
does not face competition from any other firm.

4. Freedom of Entry and Exit:


Under monopolistic competition, firms are free to enter into or exit from the
industry at any time they wish. It ensures that there are neither abnormal
profits nor any abnormal losses to a firm in the long run. However, it must be
noted that entry under monopolistic competition is not as easy and free as
under perfect competition.

5. Lack of Perfect Knowledge:


Buyers and sellers do not have perfect knowledge about the market
conditions. Selling costs create artificial superiority in the minds of the
consumers and it becomes very difficult for a consumer to evaluate different
products available in the market. As a result, a particular product (although
highly priced) is preferred by the consumers even if other less priced products
are of same quality.

6. Pricing Decision:
A firm under monopolistic competition is neither a price- taker nor a price-
maker. However, by producing a unique product or establishing a particular
reputation, each firm has partial control over the price. The extent of power to
control price depends upon how strongly the buyers are attached to his brand.

7. Non-Price Competition:
In addition to price competition, non-price competition also exists under
monopolistic competition. Non-Price Competition refers to competing with
other firms by offering free gifts, making favourable credit terms, etc., without
changing prices of their own products.

Firms under monopolistic competition compete in a number of ways to attract


customers. They use both Price Competition (competing with other firms by
reducing price of the product) and Non-Price Competition to promote their
sales.

Demand Curve under Monopolistic Competition:


Under monopolistic competition, large number of firms selling closely related
but differentiated products makes the demand curve downward sloping. It
implies that a firm can sell more output only by reducing the price of its
product.

As seen in Fig. 10.4, output is measured along the X-axis and price and
revenue along the Y-axis. At OP price, a seller can sell OQ quantity. Demand
rises to OQ1, when price is reduced to OP1. So, demand curve under
monopolistic competition is negatively sloped as more quantity can be sold
only at a lower price.
MR < AR under Monopolistic Competition:
Like monopoly, MR is also less than AR under monopolistic competition due
to negatively sloped demand curve.

Demand Curve: Monopolistic Competition Vs. Monopoly:


At first glance, the demand curve of monopolistic competition (Fig. 10.4) looks
exactly like the demand curve under monopoly (Fig. 10.3) as both faces
downward sloping demand curves. However, demand curve under
monopolistic competition is more elastic as compared to demand curve under
monopoly. This happens because differentiated products under monopolistic
competition have close substitutes, whereas there are no close substitutes in
case of monopoly.

Let us prove this with the help of Fig. 10.5 (Proof is given just for reference).
We know, price elasticity of demand (by geometric method) at a point on the
demand curve is given by: Ed = Lower segment of demand curve / Upper
segment of demand curve.
At price ‘OP’, price elasticity of demand under monopolistic competition is
BC/AB and under monopoly is EF/DE. Fig. 10.5 reveals that BC > EF and DE
> AB. So, BC/AB > EF/DE.

It means, demand curve in case of monopolistic competition is more elastic as


compared to demand curve under monopoly.

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What Is an Oligopoly?
An oligopoly is a market structure where a few, large firms control most of the market. If you think
about amonopoly, where a single entity controls the entire market, or perfect competition, where
there are many smaller companies selling the same goods and services, we needed to find a happy
medium - something between having a store on every corner but not having one brand that rules
them all. So, oligopolies were formed.

Examples of Oligopoly
Once again, to understand how these industry structures work, it's helpful to think about an industry
you are familiar with that could be an oligopoly. For our purposes here, let's say if there are three to
four companies that control most of the market, it's an oligopoly. Utility companies are often set up
as regional monopolies, so they don't help us. Gas stations are closer to perfect competition, so that
doesn't provide much insight.
Take a second and think about it: what industry in the United States has three to four companies that
essentially rule the market? I bet you thought of a few: maybe oil companies, maybe airlines, maybe
public accountants. All excellent examples. For our example, let's use one we are probably all
familiar with, and one that constantly shows us how oligopolies behave towards each other and
customers: mobile phone providers.
So, in the mobile telephone market, we really have AT&T, Verizon, T-Mobile, and Sprint. There are
others in there: StraightTalk, Cricket, U.S. Cellular, and Boost. One of the most important things to
remember about an oligopoly is that the big players are not the only players in the market; they just
have a significant amount of the market share. If the eight providers I listed above all have about
10% market share, and a few smaller companies made up the rest of the market, we wouldn't have
an oligopoly.
But, take a guess at how much market share the top four providers have. What do you think? 50?
65%? 80%? Well, AT&T and Verizon both have about 34% each, so there goes 68% of the pie. T-
Mobile has about 16%, and Sprint has about 15%. That means the top four competitors in the mobile
phone industry have 99% of the market! Now, next time you hear the Justice Department tell AT&T
they can't acquire Sprint, it might make more sense. An AT&T that owned Sprint would have 50%
market share!