Monopolistic Competition – Explanation & Real Life Applications

Monopolistic Competition

We have briefly explained it earlier in our previous post. But in case for those who haven’t read that we will discuss it from the Theory to the the Real Life Application.

According to William Baumol, “The term monopolistic competition refers to the market structure in which the sellers do have a monopoly (they are the only sellers) of their own product, but they are also subject to substantial competitive pressures from sellers of substitute products.”

In Monopolistic Competition sellers sells the products which have close substitutes, but not the perfect substitutes, which is a characteristic of monopoly & there is a large number of sellers and buyers of products, which is a characteristic of perfect competition, So it has the characteristics of both monopoly and perfect competition.

The product of each seller is different from the other in one way or the other, such as difference in brand, shape, color, style, trademarks, durability, and quality. Therefore, buyers can easily differentiate among the available products in more than one way, (this is a feature of monopoly) this difference in products is called Product Differentiation, it also helps firm’s to create Brand Loyalty.

Examples – Car Companies produces cars, all cars are different from each other in some way. Similarly Clothing Brands or Companies, Shoe Companies, Bike Companies and so much more which you can find around you with a brand name.

Due to the product differentiation sellers can sell their products at different prices, to maximize their profits. But there is a limit to it because their products have close substitutes, if sellers charge high price than their competitors for their products, consumers can shift to the close substitutes of their products, & if sellers charge less than their competitors for their products, consumers can get suspicious about their products and the intentions of sellers. So the sellers in the monopolistic competition have to fix the prices in a range, so they can partially control the prices of their products & earn profits.

Firms earns Normal Profits under Monopolistic Competition in the Long Run & has Partial Control over price, which leads to Partial Monopoly Power.

Average Revenue is equal to the Average Cost in the Long Run, (AR=AC), in Monopolistic Competition.

Due to a large number of close substitutes of a product in the market, Elasticity of Demand of the firm’s product tends to be high, means a little bit of change in price of product causes a large change in its Demand, ( If the price is increased the by one unit then decrease in demand will be more than a unit and if the price is decreased by one unit then demand will increase by more than a unit or percentage change in quantity demanded is greater than percentage change in price of the product, Ed>1 ).

Now comes the Advertising Cost,

Advertisement is the most important constituent of the selling cost which affects demand as well as price of the product, it also helps the monopolists to increase their market share and Brand Loyalty. And there is more reason to advertise because they are selling products which have close substitutes, so advertisement is a must.

Lack of Perfect Knowledge

The buyers and sellers do not have the perfect knowledge of the products in the market. There is a large number of products each being a close substitutes of the other.So this is nearly impossible for the buyers to know all about these products and their qualities and their prices. Similarly, sellers does not know the the exact preference of buyers.

Lack of Perfect Mobility of Factors of Production 

This is because if an firm is willing to move its factors of production or goods and services, it has to pay heavy transportation cost and other charges depending on the policy of the government in that locality or state or country & there can be other unforeseen expenses too. This leads to difference in the prices of products of firm.

Free Entry and Exit of Firms

There are no restrictions of the firms to enter in or exit from the industry. However there may be products of some firms which are legally patented, so the new firms entering in this industry can’t produce and sell identical products. Example – No rival firm can produce or sell a patented item like Woodland brand of shoes.

Slope of the Demand Curve

Partial control over price leads to Downward Sloping Demand Curve of the firm, quantity sold increases when price is reduced and decreases when price is increased.

Average Revenue is greater than Marginal Revenue. (AR>MR) under monopolistic competition.

Non-Price Competition

Non-Price Competition is a marketing strategy adopted by the a firm to increase its market share by promoting its product through advertisement or publicity. In this strategy firms avoid getting into price war.

Examples – A firm offers better service, after sale of the durable goods, like the service facility for AC, TV, Refrigerate when required, even when the price is not lowered or increased.

There is a difference between Producer & Seller, all Producers are seller because they sell their products to other seller or to consumers, But all sellers are not producers, because they may be selling the products manufactured by other producers.

Real Life Applications

Suppose you are entering in an industry as a Producer, Then you must know about the markets.

And Ask Yourself some Questions –

Q 1. Is this the Industry I want to enter and Produce a ABC Product ?

Q 2. What is my Product ?

Q 3. How much Knowledge Do I have about the industry and the product ?

Q 4. What resources Do I have ?

Q 5. What is my current Financial Situation ?

Q 6. How much budget Do I have ? And Is it sufficient to get to the other side or to succeed in this field or Industry ? 

Q 7. What is the difference in my Product and my Competitor’s ? 

Q 8. How much competition I’m going to face ?

Q 9. Is this a cyclic industry or ever growing ?

Q 10. How long I wish to be in this industry ? And what will be exit plan ?

Q 11. What will be my strategy to survive in the long run as well as in the short run ?

Q 12. What will be Advertising Strategy, budget, medium of advertisement ?

Q 13. At What price it will be sold and what are the prices of its close substitutes ?

Q 14. How much time Do I have to give to this Business ?

Q 15. How am I going to cover the unforeseen expenses ?

Q 16 What is that you’re expecting from this Venture ?

Q 17. How can I create a brand name for my product ?

Q 18. What will be the expected profit in starting, in midway, in Long Run ?

Q 19. Can I afford to lose what I am going to invest in this venture, if it didn’t go well ?