Monopolistic competition arises when many companies offer rival products or services that are similar but not exact substitutes.
An Introduction of Monopolistic Competition
Monopolistic competition is a market condition characterized by intense rivalry between businesses offering comparable products. Because of the competition, businesses can make money, but doing so demands creativity. Understanding this idea can help you better comprehend the fundamentals of microeconomics and how the economy works.
We will further discuss monopolistic competition, discuss its features, and examine how monopolistic competition differs from perfect competition.
What is Monopolistic competition?
In a market with monopolistic competition, numerous businesses sell comparable but marginally different goods. This kind of scenario exists between an openly competitive market and a full monopoly when assessing its levels of competition.
In a monopolistic competition market, no single business has a complete monopoly over any rivals, and businesses have some power over the pricing they set for their services. As a result, businesses can enter a market rapidly when they believe there is a chance of making money there and exit when they believe there is a smaller chance of doing so.
Businesses in these types of marketplaces frequently make money in the short term, but making money long term may take more innovation.
A market with a monopolistic structure can be compared to a combination of perfect competition and a monopoly. While perfect competition and monopoly are at opposite extremes of the spectrum, monopolistic competition lies in the middle.
However, there are also few entry barriers, easy market access, and easy market departure, which is comparable to perfect competition.
In a nutshell, monopolistic competition refers to a market structure in which numerous competitors offer marginally dissimilar goods. They then compete on criteria other than pricing, such as reliability, and quality.
9 Characteristics of Monopolistic Competion
- Free access to the market and exit: Free exit from an economic market indicates that a corporation can quit a market relatively freely if it incurs financial losses, whereas free entry from an economic market means that a business can start selling a good or service with few barriers to entry.
Even though starting a firm has expenses, monopolistic competition's flexibility makes it possible for businesses to enter and quit relatively quickly. This is crucial because once a business starts to make money, other businesses frequently strive to enter the market to reap the same rewards, necessitating the need for businesses to prepare for how competition may affect their own earnings.
- Multiple Business: Within a market with monopolistic competition, there exist several enterprises. Due to a large number of businesses, no one business has much control over the choices made by its rivals.
For instance, if a business raises prices excessively, customers might simply switch to a different brand. In contrast, if it cuts expenses too much, a customer can think its goods are subpar and cease buying them.
- Lack of Consumer Knowledge: For customers to make wise purchasing selections, information like cost and quality is frequently taken into account. It might be challenging for customers to accurately weigh all of their options in a fiercely competitive market with dozens of options that are almost identical.
Companies exploit this to create a perception of difference through advertising and marketing campaigns, even if there may be no actual difference because consumers rarely have complete knowledge about every product they purchase.
- Profits: Within a market with monopolistic competition, businesses may make exceptional profits in the near run. Consumers frequently do this because they want to explore new brands or take advantage of special offers.
Many businesses see profits that decline to a more regular level when more businesses enter the market. Companies can either innovate, distinguish their offerings, or completely exit the market to change this. Many businesses make short-term profits due to the low entry and exit barriers, but they soon face competition that could cause their margins to decrease.
- Selling Cost: Each firm invests more money in promoting its product amid monopolistic competition than it otherwise would. To sell its goods as widely as possible, the company places advertisements in newspapers, movies, magazines, radio, and television, among other media. Selling costs are the sum of the investments made in all of these.
- Price Influence: Each company has some degree of control over the cost of goods. In monopolistic competition, a firm's limit end income curve and average income both decline like monopolies. In this case, the firm can lower prices for more products sold and raise prices for fewer products sold.
Due to product diversification under monopolistic competition, a firm has control over the cost of its manufacturing. But because there are near substitutes for the opposite product, firms in monopolistic competition do not fully manage costs. Every company's costs are impacted by the pricing strategies of its rivals in the market, but only to a certain extent.
- Possible short-term supernormal earnings: Supernormal profits can be achieved by taking fair advantage of the market gap that exists in monopolistic businesses. For instance, if we talk about fashion, there can a whole new manufacturer can could enter the market with a brand-new design or idea. Now, that could have a possibility to rule the market in the coming years.
If the business is well-liked by its customers, high levels of demand are advantageous. In the near term, these result in above-average earnings before other businesses catches on. Their further strategies include making identical products that resembles the original product of the company. This strategy will not only increase their sales multifold but will also lead to a striking hike in their profits.
- Long-term normal profits: As more competitors enter the market over time, profits decline. Low entry barriers allow new businesses to see any above-average earnings and enter to take a cut. Therefore, while some businesses may benefit temporarily from new items, the emergence of competition causes these supernormal profits to decline once more.
- Non-price rivalry: Businesses compete on the quality of their goods and services because the market offers a variety of products. Although, this can be accomplished by having more attentive staff and reduced wait times. Apart from this, businesses also compete on various other grounds like branding/advertising, location, and quality.
How does Monopolistic Competition work?
When one business controls an entire sector and can set prices for its goods without worrying about rivalry, that situation is known as a monopoly. Monopolies restrict consumer options and regulate the volume and standard of production.
Monopolistic competitive businesses are forced to compete with one another, limiting their capacity to significantly raise prices without harming demand and giving customers a variety of product options. More frequently than monopolies, which are discouraged in countries with a free market, there is monopolistic competition.
Graphical Presentation of Monopolistic Competition
- Short Run Curve: Businesses engaged in monopolistic competition can achieve supernormal profits in the near term. For instance, a brand-new clothing company might create a cutting-edge design that immediately becomes popular. Short-term buyers swarm to purchase it. Competitors are aware of this, though, and will produce similar designs in an effort to win back clients. Over time, competitors will flood the market in an effort to capitalize on the innovative design, lowering profits from supernormal to "ordinary."
They will continue to create until Marginal Revenue equals Marginal Cost, as with other profit-maximizing businesses. This implies that a business won't continue to create well if doing so is no longer lucrative. The graphs above and below show that average costs rise as new competitors enter the market. This is because businesses are unable to take advantage of economies of scale.
The company that is producing above-average profits will first boost production until marginal costs equal marginal revenue. However, as new firms open, they will steal consumers from the incumbent company, forcing it to cut back on production. As a result, the production process may become more inefficient, increasing the cost per unit to.
- Long-run Curve: Long-term increased competition causes average costs to rise while earnings stabilize at normal levels. Firms will continue to seek to maximize profits, which will lead them to increase output until Marginal Revenue (MR) = Marginal Cost (MC).
The intersection of MR and Long-run Marginal Cost (LRMC) on the diagram illustrates this. The company will then sell its goods at the price at where it intersects the demand curve or price PL. After that, the long-term average costs proceed through this stage. Long-term profit for the company is now impossible.
Long-term refers to the period of time during which businesses might upgrade their facilities, launch new products, and withdraw from the market. Remember that differentiating products in monopolistic competition does not make them identical.
The Conclusion:
When numerous businesses provide competing goods or services that are comparable but not exact alternatives, monopolistic competition develops. For instance, Clothing and hair salons, and Burger and pizza joints are two examples of sectors with monopolistic competition. Competitive businesses frequently use branding or discount pricing methods in their pricing and marketing initiatives in order to gain market share.