- It is a market structure with many firms which produce heterogeneous products (branded goods) that are sold at different prices; the firms have little influence over the market price, and other firms can enter and leave the industry at any time”.
- It is an industry characterized by many firms that produce differentiated products (branded goods) which are sold at different prices.
The theory of Monopolistic competition was developed by Edward Chamberlain. He simply referred to it as “a group of firms that produce differentiated products which are sold at different prices”. The products are not perfect substitutes for one another because of the difference in their content, like quality, taste, effect, etc. However, they are regarded as competitive products as consumers substitute one for another in case of (an acute) shortage of a particular product.
Examples are abound (many) in beverage: Lipton tea, City Tea, Red Tea, Overtea, Bournvita, ‘Milo, Pronto etc; drug: Panadol, Phensic, APC, Cordin; Milk: Peak, Coast, Nido, Carnation, Cowbell, etc.; detergent (soap): Omo, Elephant, Surf. Lux, Joy, delta, Venus, Premier, Sunlight, etc; Radio and Television set: Philip, National, Orion, Trident, Sony, President, JVC, Sharp, Panasonic etc. And different brands of baby food, matches, sugar and a host of others.
The above catalogue (list) of branded goods will definitely enable readers to understand the concept of monopolistic competition. We hope you are now aware that monopolist competition is a group of firms that produce similar branded goods, like automobile (vehicles), clothes, electronics and those mentioned above. And the similar assorted goods, like different brand of tea, are sold at prices which are slightly different from one another. And due to the difference in taste, quality, effect, etc ., the producers have little measure of control over their prices. And it is therefore a different market structure from that of perfect competition in which the firms don’t have any influence (control) over the market price.
Monopolistically competitive firms have highly elastic demand curve. While the entire industry has less elastic demand curve. And this is quite different from a firm under perfect competition that has perfectly (completely) elastic demand curve (horizontal demand curve).
Characteristics of monopolistic competition (MC)
The following are the important features of MC:-
- Many firms: The industry consists of many firms that produce specific type of branded goods.
- Heterogeneous goods (Non identical goods): The goods are differentiated from one another through trade mark, branding, packaging, colouring, etc.
- Non-fixed prices: Different brands (goods) are sold at different prices.
- Restricted entry: Firms can’t enter the industry at any time. Entry is restricted with aid of licence, registration fees, etc ..
- Preferential treatment: They give preferential treatment to their customers. And this is in form of free delivery and repair services, award of discount and credit, etc.
- Absence of perfect knowledge: The firms don’t have a thorough knowledge of the market. They make independent economic decisions; and they don’t know the level of output and cost of other firms.
- Immobility of factors of production: Factors of production can not easily be moved from areas of surplus to areas of scarcity.
Short-run equilibrium of monopolistic competition
A monopolistically competitive firm, like other firms, makes abnormal profit in the short run. The discussion of short run equilibrium of all market structures are almost the same.
Long run equilibrium under M.C
The awareness of the supernormal profit in the short run encourages more firms to enter the industry. As more and more firms enter the industry, total output and supply will be greater than total demand. This lowers prices.
Recall that if supply exceeds demand price falls. As long as entry continues and supply increases and overshadows total demand, price will be on downward trend (continues to decrease). The entry and increase in total output continue in the industry until the price or demand curve falls below the minimal point of the AC curve. This brings about losses.
Fig. 19: shows long run equilibrium of a firm under imperfect competition. Excess capacity: 7 – 5 = 2.
The persistent occurrence of losses in an industry is a pointer (signal) to new firms to leave the industry. It also discourages prospective people from going into the industry. This situation reduces the number of firms and aggregate supply in . the industry. As the total output or supply decreases, the price gradually rises. This trend continues until the D/AR curve moves upward and just tangential to the negatively sloped portion of the AC curve as indicated in figure 19.
This implies that the price is equal to cost (average total cost – ATC) at this point; also marginal revenue (MR) equals marginal cost (MC) at this point. And the existing firms only earn normal profit but not abnormal profit as shown in the short run equilibrium. Thus there is neither tendency for entry nor for exist. And the industry is therefore in the long run equilibrium.
They include the following:-
- Produce a variety to satisfy different tastes: They make a very large number of different types of goods available in the market. This enables them to satisfy different tastes of consumers.
- High quality: The producers always intensify much efforts to improve the qualities of their various products in order to compete favourably in the market.
- Awareness of products’ qualities and effects: They make the public aware of the qualities and different effects of their products. This guides consumers in the process of buying branded goods.
- Standardization: They produce standardized products. A particular brand has same size, weight, quality, package, etc
- Employment of skilled labour: They employ specialists in different departments in order to raise the products’ qualities and volume of sale. This creates employment opportunities for skilled labour.
- Excess capacity – unexploited resources: They accumulate excess capacity; i.e ., the plants, machines, etc ., are not fully utilized. Thus, they are less productive than those in perfect competition.
- High cost of production: They have relatively high cost of productions as they don’t produce at the minimum point of the AC curve.
- High prices: They sell at relatively high prices. This reduces the quantity of goods which consumers can afford.
- Exploitation of consumers: They are both price makers and quantity adjusters. They often reduce output and supply in order to raise prices and maximize profit at the detriment (expense) of the consumers ..
- No perfect knowledge: Producers, sellers and buyers do not have a thorough knowledge of the market as there is no free flow of information throughout the market.
- Destructive competition: They are seriously involved in cut-throat competition. Rivalry, price and non-price competitions are very common practice in imperfect competition. They unnecessarily raise overall cost which is paid by consumers in terms of high prices.