Monopolistic Competition

What is monopolistic competition?

Monopolistic competition exists when many firms offer competing products or services that are similar, but not perfect, substitutes.

The barriers to entry in a monopolistically competitive industry are weak and the decisions of a firm do not directly affect its competitors. Competing companies differentiate themselves based on pricing and marketing decisions.

Key points to remember

  • Monopolistic competition occurs when many companies offer similar but not identical products.
  • Firms in monopolistic competition differentiate their products through pricing and marketing strategies.
  • Barriers to entry, or costs or other obstacles that prevent new competitors from entering an industry, are low in monopolistic competition.

Understanding Monopolistic Competition

There is monopolistic competition between a monopoly and perfect competitioncombines elements of each and includes companies with similar, but not identical, product offerings.

Restaurants, hair salons, housewares, and clothing are examples of monopolistically competitive industries. Items like dish soap or hamburgers are sold, marketed and priced by many competing companies.

Demand is highly elastic for the goods and services of competing companies and pricing is often a key strategy for these competitors. A company can choose to lower its prices and sacrifice a higher price profit margin, hoping for higher sales. Another may increase its price and use packaging or marketing that suggests better quality or sophistication.

Companies often use distinct marketing strategies and Branding distinguish their products. Since products all serve the same purpose, the average consumer often doesn’t know the precise differences between different products, or how to determine what a fair price might be.

Characteristics of monopolistic competition

Low barriers to entry

In monopolistic competition, one firm does not monopolize the market and multiple firms can enter the market and all of them can compete for market share. Businesses do not need to consider how their decisions influence their competitors so that every business can operate without fear of increasing competition.

Product differentiation

Competing companies differentiate their similar products with different marketing strategies, brand names and quality levels.

Pricing

Firms in monopolistic competition act as price makers and set prices for goods and services. Firms in monopolistic competition can raise or lower their prices without starting a price war, which is often found in oligopolies.

Elasticity of demand

Demand is very elastic in monopolistic competition and very sensitive to price variations. Consumers will switch brands for items like laundry detergent solely based on price increases.

Advantages and disadvantages of monopolistic competition

Monopolistic competition has both advantages and disadvantages for businesses and consumers.

Advantages

  • Few barriers to entry for new businesses

  • Variety of choices for consumers

  • Corporate decision-making power over pricing and marketing

  • Consistent product quality for consumers

The inconvenients

  • Many competitors limit access to economies of scale

  • Inefficient company spending on marketing, packaging and advertising

  • Too many choices for consumers means extra research for consumers

  • False advertising or imperfect information for consumers

What is the difference between monopolistic competition and perfect competition?

In perfect competition, the product offered by competitors is the same item. If a competitor increases its price, it will lose all its market share to other companies based on the forces of supply and demand in the market, where prices are not set by companies and sellers accept prices determined by market activity.

In monopolistic competition, the forces of supply and demand do not dictate prices. Companies sell similar but distinct products, so the companies determine the price. Product differentiation is the main feature of monopolistic competition, where products are marketed by quality or by brand. Demand is very elastic and any change in price can cause demand to shift from one competitor to another.

How does monopolistic competition work in the short and long term?

Firms aim to produce a quantity where marginal revenue equals marginal cost to maximize profits or minimize losses. When existing companies make profits, new companies enter the market. Both the demand curve and the marginal revenue curve shift and new firms stop entering when all firms make no profit in the long run. If existing businesses suffer a loss, some businesses will exit the market. Companies stop leaving the market until all companies start making zero profit. The market is at balance in the long term only when there is no more exit or entry into the market or when all companies are not making any long term profit.

Which industry is an example of monopolistic competition?

Monopolistic competition is present in restaurants like Burger King and McDonald’s. Both are fast food chains that target a similar market and offer similar products and services. These two companies actively compete with each other and seek to differentiate themselves through brand recognition, pricing, and by offering different food and beverage packages.

What is the difference between monopolistic competition and a monopoly?

A monopoly is when a single company dominates an industry and can set prices for its product without fear of competition. Monopolies limit consumer choices and control the quantity and quality of output. Monopolistic competitive firms must compete with others, limiting their ability to substantially raise prices without affecting demand and providing a range of product choices to consumers. Monopolistic competition is more common than monopolies, which are discouraged in Free market nations.

The essential

Monopolistic competition exists when many companies offer competing products or services that are similar but not exact substitutes. Hair salons and clothing are examples of monopolistically competitive industries. Pricing and marketing are key strategies for competing businesses and often rely on branding or pricing discount strategies to increase market share.

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