Monopolistic Competition

1. What is Monopolistic Competition?

Monopolistic competition is a form of imperfect competition in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers in one respect to the other.

In this type of market, a firm is characterized by some features of monopoly and some features of competition. It has elements of monopoly because product differentiation provides the firms limited control over the price of the product. Accordingly as under monopoly each firm faces a negatively sloped demand curve. For example, Hindustan Lever Ltd. enjoys monopoly right on the trade-market Lux. No other firm in the country can name its soap as Lux. However other firms can manufacture their bathing soaps under their own trade-mark, such as, Hamam, Breeze etc. In other words, there is freedom to produce substitute of Lux soap. It is similar to perfect competition to the extent that there are many firms in the market and is freedom of entry and exit. Also, it is similar to monopoly to the extent it allows partial control over price through product differentiation.

According to J.S. Bains, ”Monopolistic competition is market structure where there is a large number of small sellers, selling differentiated but close substitute products.”

In the words of Baumol,”The term Monopolistic competition refers to the market structure in which the sellers do have a monopoly (they are the only sellers) of their own product, but they are also subject to substantial competitive pressures from sellers of substitute product.”

Many markets are monopolistically competitive; common examples include the markets for restaurants, cereal, clothing, shoes, and service industries in large cities. The “founding father” of the theory of monopolistic competition was Edward Hastings Chamberlin in his pioneering book on the subject Theory of Monopolistic Competition (1933).

2. Characteristics of Monopolistic Competition

Main characteristics are as under:

1. Large number of Firms and Buyers: Under Monopolistic competition there is a large number of firms producing differentiated product and also a large number of buyers.

2. Product Differentiation: is a salient feature of Monopolistic competition. Product Differentiation means that at any point of time the consumer will be offered a wide range of types, styles, brands and quality gradations of any given product. In other words, product differentiation refers to that situation wherein the buyers can distinguish one product from the other in a certain way. Number of firms is large but their products differ in one respect or the other. However, their products are close substitutes. Product differentiation arises due to difference in shape, colour, durability, quality, size, etc. There are many instances of product differentiation , such as, Lux, Hamam, Rexona, etc. among bathing soaps. Similarly, Pepsodent, Colgate, Choice, etc. among the toothpastes. Producers prefer to differentiate their product because it facilitates increase in market share and because it allows partial control over price.

3. Freedom of Entry and of Exit of Firms: As in case of perfect competition, firms are free to enter and leave the industry under monopolistic competition. Here it may be noted that Chamberlin has used the term ’group’ rather than ’industry’ for the number of firms producing differentiated products under monopolistic competition.

4. Selling Costs: Each firm spends a lot of funds on advertisment and publicity of its products. With a view to selling more and more units of the product it gives wide publicity of its products in newspapers, cinemas, journals, radio, T.V. etc. The expenses so incurred are called selling costs.

5. Partial Control over Price: Each firm has limited control on the price of its product. Average and marginal curves of a firm under monopolistic competition slope downwards as in case of monopoly. It means if a firm wants to sell more units of its product it will have to lower the price per unit. Or, only less can be sold at a higher price. Product differentiation enables a firm under monopolistic competition to have limited control over the price of its product. Unlike monopoly, complete control over the price is not possible because of the availability of large number of close substitutes in the market. Accordingly the price policy of the firm is influenced to a great extent by the price policy of its competitors in the market.

6. Limited Mobility: Under monopolistic competition neither the factors of production nor the goods and services are perfectly mobile.

7. Imperfect Knowledge: Buyers and sellers lack perfect knowledge about the price of the product because it is not possible to compare the products of different firms due to product differentiation. Buyers develop a liking for a particular brand of wide range of differentiated products by a particular firm. They must buy it even if its price is a little higher than the product of other firms. Similarly, owners of factor services are also not fully aware about the price of factor services offered by other firms.

8. Non-price competition: Another feature of monopolistic competition is that different firms may compete with one another without changing the price of the product. Take for instance firms producing washing powder, ’Surf Excel’ and ’Ariel’. With one pack of ’Surf Excel’, the company may give a free gift of one tumbler. Likewise, with one pack of ’Ariel’ the other company may give a stainless steel spoon as a free gift. In this way, firms compete with each other in offering free gifts and other services to attract more and more customers. Such a competition is called non-price competition.