Monopolistic Competition

Updated on 2023-08-29T11:59:53.823728Z

What is monopolistic competition?

Monopolistic competition is an imperfect competitive market. A monopoly has a single producer, an oligopoly has a few dominating firms, but there are a large number of firms in monopolistic competition. 

Perfect competition and monopoly sit at the opposite ends of the competition spectrum. A market with perfect competition assumes perfect information among many buyers and sellers, trading homogenous products. 

Imperfect competition includes monopolistic competition, oligopoly, duopoly, monopoly. Industries that usually fall under monopolistic competition include clothing, footwear, restaurants etc. But why these markets have monopolistic competition?

Monopolistic competition will have a large number of buyers and sellers dealing with differentiated products with low barriers to entry and exit. With product differentiation capabilities, consumers also perceive goods as unique to each other. 

Moreover, products and services in monopolistic competition are not perfect substitutes, and consumers can differentiate on account of brand, location, quality. 

Firms in monopolistic competition undertake decisions independently, and there exists some degree of market power among producers. They maximise profits when marginal costs equal marginal revenue. 

When firms compete under monopolistic competition, it leads to an increase in selling expenses, which are aimed to influence the demand curve of the firm. Unused capacities would also hurt firms because the cost will be higher than the profit maximising output. 

Some industries with monopolistic competition 

1. Restaurants are often large in numbers, but they largely sell different food, cuisine etc. In addition, there is usually no barriers to entry. 
2. Consumer electronic market has great intensity of differentiated products in terms of features. There are many sellers and buyers in the market, and globalisation has also increased the number of sellers. 
3. Consumer staples like toothpaste, soaps, detergents also fall under monopolistic competition since there are several large players and many small players. These products are differentiated on the basis of ingredients, use etc. 
4. There are many bakery shops in a city or town selling slightly different products in terms of say taste, price, appearance to consumers. If the brand is famous in the town, the firm could dictate the prices as well. 
5. Generally, there is an abundance of hairdressers. But the service offered by each would not be similar. If a customer had an unpleasant experience with any barbershop, he will likely not go to the same place again. On the contrary, when the customer is satisfied, he may be reluctant to visit other barbershops.  

Market power 

The demand curve for an individual firm is downward sloping in monopolistic competition. It means a decrease in prices will lead to an increase in quantity demand. Because firms have market power stemming through product differentiation, the price can be influenced without losing customers. 

Firms that achieve a price leadership are positioned as a price setter and dictate the prices of products. Since competition is intense, firms emphasise on product differentiation to achieve market power. 

They seek to reflect that products are an imperfect substitute for each other, and this is gained by differentiating factors, including brand awareness, quality. As a result, firms are able to increase the price without losing the consumer base. 

Moreover, every firm in monopolistic competition aspires to dominate the market and expand the size of the market. Therefore, firms incur selling expenses to influence the quantity demanded at different price levels.

Product differentiation

Product differentiation is a strategy of the seller to differentiate their products from other products in the market. In monopolistic competition, there is a significant level of non-price competition among many firms. 

It becomes imperative to build favourable product differentiation for firms operating in a monopolistic market. Product differentiation is essentially the key in monopolistic competition. 

Firms undertake research to improve differentiation and demonstrate unique aspects of the product through marketing and advertising. Differentiation does not mean creating differences between the products. 

Varying consumer’s perception regarding the product is differentiation. Some factors that drive differentiation include distribution, marketing, and availability. Product differentiation could be in terms of quality, which will likely result in a higher price. 

Producers can differentiate products on the basis of design and features offered by the product. Sales promotion and advertising also differentiate products among consumers. Buyers can ignore price and features depending on the brand. 

Overall, the objective of product differentiation is to create a unique image of product among existing and prospective consumers. Firms always aspire that product differentiation should deliver non-price competitive benefits.

Marketing in Monopolistic competition

A secret sauce of many successful companies has been branding and advertising. A marketing strategy is very crucial for a firm to achieve its long-term goals as well as short-term. 

Since firms in monopolistic competition race to differentiate products, advertising, and branding is often a go-to strategy for firms. Firms try to engage with clients through various point of contacts such as television, hoardings. 

Advertising is a practice for companies used to communicate with customers. Its objective is to inform, educate and familiarise existing consumers or prospective consumers with the products and brand. Moreover, advertising is used to develop brand image and awareness. 

The motive of branding is to ignite a response or reaction among consumers when they come across a brand or its products. Brand reputation is constructed through consumers’ previous experience and continuous advertising. 

Brand reputation, as a non-price differentiating factor, is perhaps the best strategy to compete in monopolistic competition. Firms also work consistently to manage brand reputation and ensure products deliver the highest quality. 

Via advertisements, the consumers are informed about the product and features, and an informed buyer knows what to buy, therefore minimising the cost of choosing product since consumer already knows the features and about the brand. 

When entering new markets, advertisements are extensively used by firms to communicate their value proposition to consumers and establish a brand image. It would eventually make consumers comfortable when they try the product. 

More importantly, failed and misleading advertisement can backfire at a brand reputation. Before the advertisement is launched, there lies an uncertainty on the expected reactions from consumers. Therefore, reputational damage to the brand and firm would also impact the firm in the market.