Monopolistic Competition: Key Characteristics
Features of Monopolistic Competition
1. Large Number of Sellers
There are a large number of firms selling closely related but not homogeneous products. Each firm acts independently and has a limited share of the market. Therefore, an individual firm has limited control over the market price. A large number of firms leads to competition in the market.
2. Product Differentiation
Each firm can exercise some degree of monopoly (despite a large number of sellers) through product differentiation. Product differentiation refers to differentiating products based on brand, size, color, shape, etc. The product of a firm is a close but not a perfect substitute for another firm’s product.
The implication of ‘Product Differentiation’ is that buyers differentiate between the same products produced by different firms. Therefore, they are willing to pay different prices for the same product produced by different firms. This gives some monopoly power to an individual firm to influence the market price of its product.
3. Selling Costs
Under monopolistic competition, products are differentiated, and these differences are made known to buyers through selling costs. Selling costs refer to the expenses incurred on marketing, sales promotion, and advertising of the product. Such costs are incurred to persuade buyers to buy a particular brand of product in preference to a competitor’s brand. For this reason, selling costs constitute a substantial part of the total cost under monopolistic competition.
It must be noted that there are no selling costs in perfect competition as there is perfect knowledge among buyers and sellers. Similarly, under a monopoly, selling costs are small (only for informative purposes) as the firm does not face competition from any other firm.
4. Freedom of Entry and Exit
Under monopolistic competition, firms are free to enter or exit the industry anytime they wish. This ensures that there are neither abnormal profits nor any abnormal losses to a firm in the long run. However, it must be noted that entry under monopolistic competition is not as easy and free as under perfect competition.
5. Lack of Perfect Knowledge
Buyers and sellers do not have perfect knowledge about market conditions. Selling costs create artificial superiority in the minds of consumers, and it becomes challenging for a consumer to evaluate different products available in the market. As a result, a particular product (although highly-priced) is preferred by consumers, even if other less-priced products are of the same quality.
6. Pricing Decision
A firm under monopolistic competition is neither a price-taker nor a price-maker. However, by producing a unique product or establishing a particular reputation, each firm has partial control over the price. The extent of power to control the price depends upon how strongly the buyers are attached to its brand.
7. Non-Price Competition
In addition to price competition, non-price competition also exists under monopolistic competition. Non-price competition refers to competing with other firms by offering free gifts, making favorable credit terms, etc., without changing the prices of their products.
Firms under monopolistic competition compete in several ways to attract customers. They use both price competition (competing with other firms by reducing the product’s price) and non-price competition to promote their sales.