In Monopolistic competition there are large numbers of buyers and sellers which do not sell homogeneous products unlike perfect competition. This is more realistic in the real world. Monopolistic competition occurs when an industry in which many firms sell products that are similar but not identical.
Monopolistic competitions try to differentiate its product. Thus it is closely related to the business strategy of brand differentiation. In monopolistic competition heavy advertising and marketing is common among firms.
Monopolistic competition combines elements of both monopoly and perfect competition. All firms in monopolistic competition relatively have low market power and they are all market makers.
Monopolistic competitive market
- The firm offer highly differentiated product
- Free entry and exit in the market ie no barriers
- Firm can make decision independently
- Customers have the preference of choosing products
- Seller becomes price setter
- Seller can charge marginally high price to enjoy some degree of market power
Features
- Product differentiation – monopolistic competition includes firms that offer similar products but are not identical. The products are differentiated not on the basis of price but the difference includes physical aspects of the product, location from where it sells and intangible aspects of the product. The product and services perform the basic function but have differences in quality such as type, colour, appearance, reputation, location that distinguish the product from each other. For ex, motor vehicles are same to move people from one point to another. But there are many types of motor vehicles such as cars, bikes, and scooters.
- Many firms – there are many firms in each product group. A product group is a “collection of similar products”. Under monopolistic markets, each firm has a small market share. This gives each firm a freedom to set price and each firm action has negligible impact on the market. A firm can cut the price to increase sales without any fear. As its action will not prompt retaliatory responses from competitors.
- Freedom of entry and exit – Like perfect competition, under monopolistic competition the firms can freely enter or exit. When the existing firms make supernormal profits, then new firms will enter. The entry of new firms leads to an increase in the supply of goods and services and this would reduce the price and thus the existing firms will be left only with normal profits. Similarly, if the existing firms are incurring losses, some of the firms will exit. This will reduce the supply which results in a decrease in price and the existing firms will be left only with normal profit.
- Independent decision making – under a monopolistic market, each firm can independently set the terms and conditions of exchange for its product. The firm does not consider how their decision will have an impact on competitors. In other words, each firm feels free to set prices and prompt heightened competition.
- Market power – under monopolistic competition, the firms have a low degree of market power. Market power means that the firm has control over the terms and conditions of exchange for its product. All firms under monopolistic competition are price makers. A firm can raise the prices of products and services without losing all its customer base. The firm can also lower prices without any effect on the competitors. Since the firm has relatively low market power, there is no barrier to entry.