Monopolistic competition combines the features of both monopoly and perfect competition. An enterprise is a monopolist when it produces a specific variety of product that is different from other products on the market. However, competition from monopolistic activity is created by many other firms producing similar, not completely identical goods. This type of market is closest to the real conditions of existence of firms producing consumer goods or providing services.
Definition
Monopolistic competition is a situation on the market when many manufacturing companies produce goods similar in purpose and characteristics, while being monopolists of a specific product variety.
The term was introduced by the American economist Edward Chamberlin in the 30s of the last century.
An example of monopolistic competition is the shoe market. The buyer may prefer a particular brand of shoes for a variety of reasons: material, design or “untwisted”. However, if the price of such shoes is excessively high, he will easily find an analogue. This restriction regulates the price of the product, which is a feature of perfect competition. The monopoly is provided by recognizable design, patented production technologies, unique materials.
Services can also act as goods of monopolistic competition. A vivid example is the activity of restaurants. For example, fast food restaurants. They all offer roughly the same dishes, but the set of ingredients is often different. Often, such establishments tend to stand out with a special sauce or drink, that is, to differentiate their product.
Market properties
The following features are characteristic of the monopolistic competition market:
- A large number of independent buyers and sellers interact on it.
- Almost anyone can start working in the industry, that is, barriers to entry into the market are quite low and more relate to the legislative registration of production activities, obtaining licenses and patents.
- To successfully compete in the market, the company needs to produce products that differ from the products of other companies in terms of properties and characteristics. Such a separation can be either vertical or horizontal.
- When setting prices for a product, firms are not guided by either production costs or the reaction of competitors.
- Both manufacturers and buyers have information about the mechanisms of the monopolistic competition market.
- Competition for the most part is non-price character, that is, competition of product characteristics. A significant influence on the development of the industry is the company's marketing policy, in particular advertising and promotion.
A large number of manufacturers
Perfect and monopolistic competition is characterized by a sufficiently large number of manufacturers in the market. If hundreds and thousands of independent sellers operate in the market of perfect competition, then in the monopolistic goods I offer several dozen firms. However, such a number of manufacturers of the same product is enough to create a healthy competitive environment. Such a market is protected from the likelihood of collusion between sellers and artificial price increases while lowering production volumes. The competitive environment does not allow individual firms to influence the overall level of market prices.
Entry Barriers
Starting work in the industry is relatively easy, however, in order to compete successfully with already existing firms, you will have to make efforts to differentiate your product and attract customers. Significant investments will require advertising and promotion of a new brand. Many buyers are conservative and trust the time-tested manufacturer more than a novice. This can make it difficult to enter the market.
Product differentiation
The main feature of a monopolistic competitive market is the differentiation of products according to certain criteria. These can be real differences in the field of quality, composition, materials used, technologies, design. Or imaginary ones, such as packaging, company image, trademark, advertising. Differentiation can be vertical and horizontal. In the process of making a purchasing decision, the buyer divides the proposed similar products according to the quality criterion into conditionally “bad” and “good”, in this case we are talking about vertical differentiation. Horizontal differentiation occurs when the buyer focuses on their individual taste preferences with other objectively equal characteristics of the product.
Differentiation is the main way a company stands out and takes a place in the market. The main task: to determine your competitive advantage, target audience and establish an acceptable price for it. Marketing tools help to promote products on the market and contribute to the growth of brand value.
With such a market structure, both large manufacturers and small enterprises oriented to work with a specific target audience can survive.
Non-price competition
One of the main features of monopolistic competition is non-price competition. Due to the fact that there are a large number of sellers on the market, a change in price does not significantly affect the volume of sales. In such conditions, firms are forced to resort to non-price methods of competition:
- make more efforts to differentiate the physical properties of their products;
- provide additional services (for example, service for equipment);
- attract customers through marketing tools (original packaging, promotions).
Profit maximization in the short run
In the short-term model, one factor of production is fixed in terms of costs, while other elements are variables. The most common example of this is the production of goods requiring production facilities. If the demand is large, in the short term only the quantity of goods that the factory capacity allows can be obtained. This is due to the fact that it takes a considerable amount of time to create or acquire a new production. With good demand and an increase in prices, it is possible to reduce production at the plant, but you still have to pay the costs of maintaining the production and the associated rent or debt associated with the acquisition of the enterprise.
Suppliers in competitive monopolistic markets are price leaders and will behave similarly in the short term. As in a monopoly, a firm will maximize its profits by producing goods as long as its marginal revenue equals marginal cost. The price of profit maximization will be determined based on where the maximum profit falls on the average revenue curve. Profit is the amount of the product multiplied by the difference between the price minus the average cost of production of the goods.
As can be seen from the graph, the firm will produce quantity (Q1), where the marginal cost curve (MC) intersects the marginal revenue curve (MR). The price is set based on where Q1 falls on the average revenue curve (AR). The company's profit in the short term is represented by a gray rectangle or quantity multiplied by the difference between the price and the average cost of production of the goods.
Since monopolistically competitive firms have bargaining power, they will produce less and charge more than a firm in perfect competition. This leads to a loss of efficiency for society, but, from the point of view of the manufacturer, it is desirable, because it allows them to make a profit and increase the surplus of producers.
Profit maximization in the long run
In a long-term model, all aspects of production are variable and therefore can be adjusted to reflect changes in demand.
While a monopolistic competitive firm can make a profit in the short term, the effect of its monopoly price will lead to lower demand in the long run. This increases the need for firms to differentiate their products, which leads to an increase in average total cost. A decrease in demand and an increase in value causes the long-term average cost curve to become tangent to the demand curve in a maximizing profit price. That means two things. First, that firms in a monopolistic competitive market will ultimately suffer losses. Secondly, the company, even in the long term, will not be able to make a profit.
In the long run, a firm in a monopolistic competitive market will produce so many products where the long-term cost curve (MC) crosses marginal revenue (MR). The price will be set where the quantity produced falls on the average income curve (AR). As a result, in the long run, the company will suffer losses.
Efficiency
Due to the diversification of the product, the company is a kind of monopoly of a specific version of the product. In this, monopoly and monopolistic competition are similar to each other. The manufacturer can reduce the volume of output, while artificially inflating the price. Thus, an excess of production capacity is created. From the point of view of society, this is inefficient, but creates the conditions for greater product diversification. In most cases, monopolistic competition is approved by society, because due to the variety of similar, but not absolutely identical products, everyone can choose a product according to their individual preferences.
Benefits
- There are no serious barriers to entry into the market. The possibility of profit in the short term attracts new manufacturers, which forces old firms to work on the product and apply additional measures to stimulate demand.
- A variety of similar, but not completely identical products. Each consumer can choose a product according to personal preference.
- The market of monopolistic competition is more efficient than monopoly, but less effective than perfect competition. However, in a dynamic perspective, it encourages manufacturers and sellers to use innovative technologies to maintain market share. From the point of view of society, progress is good.
disadvantages
- Significant advertising costs, which are included in the cost of production.
- Partial capacity utilization.
- Inefficient use of resources.
- Deceptive maneuvers of manufacturers, creating an imaginary differentiation of the product, which misleads consumers and creates unreasonable demand.
Monopolistic competition is a market structure in which several dozen manufacturers of similar but not absolutely identical goods operate on the market . Such a market structure combines the features of both monopoly and perfect competition. The main condition for monopolistic competition is product diversification. The company is a monopoly of a specific version of the product and can overpriced, creating an artificial shortage of goods. This approach encourages firms to use new technologies in production in order to remain competitive in the market. However, such a market model contributes to the emergence of excess production capacity, inefficient use of resources and an increase in advertising costs.