Monopolistic Competition

Monopolistic Competition:

The term monopolistic competition is frequently used interchangeably with imperfect competition. However, this doesn’t seem right because there does exist a distinction between the two terms, however delicate it may be.

Imperfect Competition and Monopolistic Competition:

We have been concerned with the analysis of forces determining price under the two extreme situations, namely, that of perfect competition on the one hand and of pure monopoly on the other. In actual life, it is almost impossible to discover a single commodity that is exchanged under conditions of perfect competition, and it is equally difficult to discover examples of pure monopolies. The reality, however, is to be found somewhere between the two extreme situations. The large majority of markets in real life display the characteristics of both monopoly as well as competition; in some, the monopoly element predominates, while in others competition holds sway. Such market situations where neither pure monopoly nor perfect competition prevails, are referred to by economists as imperfectly competitive markets. In other words, imperfect competition is a market situation that lies between the two extremes of perfect competition and pure monopoly. Imperfect competition is a very wide term and includes a great variety of market forms, ranging from near-monopoly (or, non-pure monopoly) at one extreme to nearly perfect competition at the other.

Before 1933, economists believed that economic factors always tended towards an equilibrium of perfect competition and that monopoly was a rare and exceptional situation. Imperfect competition as a market situation did not receive any attention at all. The publication of Mrs. Joan Robinson’s Economics of Imperfect Competition in Great Britain, and Prof. E. H. Chamberlin’s Theory of Monopolistic Competition about the same time in the U.S.A., marked the beginning of the development of the theory of imperfect competition. Obviously, this theory was nearer to conditions of real life than that of perfect competition or pure monopoly. In actual life, we find that sellers do differentiate their products through various devices, and also often combine together to exploit the consumers. In consequence, competition has become imperfect today.

A major difficulty in formulating the theory of imperfect competition is that it takes too many forms so we can study only the important forms of imperfect competition. The standard classification of market situations is based on just two ideas-

• the number of firms in an industry.
• the homogeneity or differentiation of the firm’s products.

Under perfect competition, two conditions must be fulfilled-

• There must be a large number of firms, each of which produces so small, a proportion of the total output of the commodity that it cannot affect the total supply by restricting its own output.
• The commodity must be homogeneous so that the customers have no special preference for the product of any one firm. If one or both of these conditions remain unfulfilled in a market situation, it is called imperfect competition.

There are two main varieties of imperfect competition-

• Monopolistic Competition.
• Oligopoly.

There is still another minor form of imperfect competition known as Duopoly, where there are only two firms share the market.

From the above discussion, it becomes evident that imperfect competition and monopolistic competition are not interchangeable terms. Imperfect competition is a much wider and more comprehensive term than monopolistic competition. In fact, monopolistic competition is only one of the many sub-categories of imperfect competition. It should not, therefore, be equated with imperfect competition. The theory of monopolistic competition has become quite important in recent years. Prof. E. H. Chamberlin of Harvard University is the architect and builder of the theory of monopolistic competition. (Monopolistic Competition is also sometimes referred to as Group Equilibrium).

Features of Monopolistic Competition:

The following are the main features of monopolistic competition.

(1) Existence of a Large Number of Firms- The first condition of monopolistic competition is that there should be a large number of firms in the market, with the largest firms accounting for a very small share of the total output of the industry. In monopolistic competition, the firms, though large in numbers, are small in size. In fact, the firms are bound to be small-sized when they are found in such large numbers in the market. This type of situation is found in those lines of production in which the economies of scale are limited, with simple techniques of production and relatively small requirements of capital. Under these conditions, the individual firms are bound to be small-sized. Examples of monopolistic competition may be found in retail trade (grocery stores), and service industries like shoe repair shops, petrol stations, and dry cleaning establishments, etc. Since the number of firms is large, each firm acts independently without bothering about the reactions of its rivals. No firm’s attention action influences the other in any significant manner. Each firm controls only an insignificant proportion of the total market output. Any action on its part, by way of extending or reducing output will have little or no effect on other firms.

(2) Product Differentiation- The second feature of monopolistic competition is product differentiation. The various firms under monopolistic competition bring out differentiated products, which are relatively close substitutes for each other, but not perfect substitutes as such. Product differentiation can be brought about in a variety of ways.

Firstly, the firms may bring about product differentiation through differences in the quality of material used, through workmanship, durability, and strength, and through differences in styling and branding and a myriad of other devices and artifices.

Secondly, the firms may bring about product differentiation by offering to their customers supplementary and other services along with the sale of the product. For example, a firm may agree to give to its customer facilities of credit, home delivery of goods, guarantee of repairs and servicing, acceptance of returned goods, etc.

Thirdly, product differentiation can be brought about through advertisement, publicity, and propaganda. This is known as sales promotion. Assuming that sales promotion is effective, the customers begin to think that the product of the firm in question is superior to that being sold by other firms.

(3) Ease of Entry and Exit- The third important feature of monopolistic competition is that there is no difficulty for a new firm to enter into or an existing firm to leave the industry. The same factors that result in a large number of relatively small-sized firms also contribute to ease of entry into and exit from the industry. The simplicity of production techniques and smallness of capital requirements do not place any serious obstacles to the entry of new firms.

Thus, under monopolistic competition, each firm acts more or less independently. Each firm formulates its own price-output policy. Each firm bases its price-output policy upon its own demand estimates and cost schedules. Each firm has its own determinate demand curve for its product, assuming the prices of other firms as given.