Monopolistic competition refers to a market condition wherein the firms have numerous competitors, and each one of them sells a different product or service. This type of markets is defined by the combination of the elements of Competitive and Monopolistic markets. Since it offers freedom of entry and exit to firms the need to differentiate one’s products and services becomes very important to stand out from the crowd.The inelastic demand curve defines this condition, and therefore the firms are free to set their prices.
A typical feature of Monopolistic Competitive markets is that the freedom of entry and high profits encourage firms to enter the market eventually causing the earnings to average out in the long run.
The inelastic demand curve defines this condition, and therefore the firms are free to set their prices. A typical feature of Monopolistic Competitive markets is that the freedom of entry and high profits encourage firms to enter the market eventually causing the earnings to average out in the long run.
Hence, we can say that all the businesses put forward their elements of uniqueness while essentially competing for the same set of target customers.
Features of Monopolistic Competitive Market
1. Every firm is free to make independent decisions about output and prices based on the cost of production, market conditions, and product type.
2. Although knowledge is widely available to all the customers or participants, however, it is unlikely that this knowledge will be perfect.
3. Entrepreneurs tend to have a crucial role to play in comparison to firms in this type of market structure due to higher risks associated with decision making.
4. Since there are no significant barriers to entry or exit, firms are free to enter or exit the market as and when they feel like.
5. Firms in monopolistic competition market can be called price makers; however, they need to deal with a downward sloping demand curve.
6. One of the critical features of this market structure is how the products are differentiated from one another. There are four types of differentiation, namely, physical, product, marketing, human capital, and distribution differentiation.
- Physical product differentiation is where the firm’s change the design, size, performance, shape, colour, and features of a product for a differentiated look and feel.
- Marketing differentiation is when the firms make their offerings unique using distinctive packaging and diverse promotional techniques.
- Human capital differentiation is a situation wherein firms create differences using the skill, conduct, and training of their employees.
- Operating through various distribution channels in comparison to your competitors like Amazon gives you differentiation through distribution.
7. Since there are a large number of independent firms competing in this market type that’s why monopolistic competitive firms are referred to as profit maximisers.
Monopolistic Competition Market Examples
Monopolistic competitive firms are readily available in industries where differentiation is possible. These include
1. Hotels and pub
2. The restaurant business
3. Consumer services like hairdressing
4. General specialist retailing.
Market Dynamics in The Short Run
When the firms reach the point of profit maximization, MC = MR, due to which output is Q and price P. If we assume that price (AR) is above Average Total Cost at Q, then the area PABC define supernatural profits.
As more and more forms mark their entry into the market the demand for the products of the existing firms becomes increasing the elastic causing the demand curve to shift to the left. This causes the price to drop doing away with supernormal profits.
Market Dynamics in The Long Run
Supernormal profits become the key attracting point in this type of market structure. For all the new entrants, it causes the demand curve for the existing forms to shift to the left. As the new entrants venture into the market, normal profits will be available. It is at this point when the firms have achieved the long-run equilibrium.
It is evident that in a monopolistic competition market the firm benefits the most in the short-term by innovating and extensive product differentiation.
Advantages of Monopolistic Competition
1. Since this market structure is free from significant barriers to entry, therefore, they are relatively contestable.
2. The desire to differentiate your offering helps in bringing diversity, utility, and choice in the market. For example, on any high street in the town, there will be a large number of restaurants for the consumers to choose from.
3. This type of market structure is less efficient than a perfect competition; however, more efficient than monopoly. On the contrary, it is imperative to remind yourself that the firms may be dynamically efficient and innovative in terms of new product design.
Disadvantages of Monopolistic Competition
1. It is not necessary that differentiation will always lead to a higher utility. There are chances that it may lead to unnecessary waste such as excess packaging.
2. In this type of market structure, if we assume that profit maximization is this only objective of the firms, then there is allocative inefficiency in the short term as well as the long run. This happens because the price is generally above the marginal cost.
As an economic model, monopolistic competition is highly realistic in comparison to the perfect competition model. It is due to this reason that many familiar and complex markets are adapting to this model.
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