Monopolistic Competition: Meaning, Features, Price determination

  • Post last modified:20 February 2022
  • Reading time:14 mins read

What is Monopolistic Competition?

Monopolistic competition is a situation of market in which the number of producers and sellers is large though not so large as to create the situation of perfect competition.

Thus, it is a compromise between perfect competition and monopoly. Under it, every producer and seller is a monopolist in his particular area due to product differentiation.

Meaning of Monopolistic Competition

Monopolistic competition is a situation of market in which the number of producers and sellers is large though not so large as to create the situation of perfect competition.

Competition is also found among different producers and sellers due to product homogeneity. Thus, monopolistic competition is a combination of both perfect competition and monopoly. Hence, it is called imperfect competition.

For example, there are several brands of soaps and every producer and sellers of these brands is a monopolist to some extent because of different brands but since all the brands are close substitutes to each other, there is a competition among the producers and sellers of these brands.


Features of Monopolistic Competition

There are some Features of monopolistic Competition are :

Large Number of Producers and Sellers

The number of producers and sellers is large but an individual producer and seller contributes only a small part of the total demand of the product.

Competition among Producers

All the producers produce different brands of a product but all of these brands are close substitutes to each other, which creates tough competition among the producers of different brands.

Product Differentiation

Though the commodities produced by different producers are identical to each other but these commodities are not identical. They are different from each other in one respect or the other. Hence, different producers sell their products at different prices,

Free Entry and Exit of Firms

There is no restriction on the entry and exit of firms. A new firm can enter into the market at any time and an existing firm can leave the market at any time.

Non-Price Competition

The competition is generally non-price competition. Different producers sell their products at different prices but they compete with each other based on quality, colour, packing, design etc.

Important Role of Selling Costs

Selling costs play more important role than the cost of production because every producer has to face severe competition from other producers. Only those producers can be successful who adopt suitable marketing policies and present their product through effective channels.

Flat Demand Curve

The demand curve tends to be flat because this is a market situation between monopoly and perfect competition.


Price determination under monopolistic competition

Monopolistic competition is the market situation between perfect competition and monopoly. Neither monopoly nor perfect competition is found in real life but only monopolistic competition. Under this, the number of producers and sellers is large and most of them work at small scale. They produce and sell the same product but their products are not exactly identical.

Under monopolistic competition, price is determined based on same principles under which it is determined under perfect competition and monopoly.

It is determined at the point at which marginal revenue and marginal cost are equal (MR = MC), because at this point the firm is in a position to earn maximum profit. If at a time, marginal revenue of a firm is more than its marginal cost (MR > MC), it is profitable for the firm to increase its production.

In order to sell more quantity of a product, its selling price should be decreased and gradually it should come down to the point of equilibrium. If, on the contrary, marginal revenue of a firm is less than its marginal cost (MR < MC), it will be profitable for the firm to curtail its production.

By doing so, it can increase selling price and gradually it will increase to the point of equilibrium. Thus, the price under monopolistic competition is determined at the point at which marginal cost and marginal revenue of a firm are equal.

Short-term Equilibrium of a Firm

Short-term refers to the period in which a firm cannot adjust supply of its product according to demand. Due to this reason, a firm cannot do much about its profit position in short-run. Therefore, in short-run, there may be three possibilitie with regard to profit

  • Abnormal profit

  • Normal or Zero profit.

  • Loss

Abnormal Profit

In short-run a firm may be in a position to get abnormal profit only when the demand of the product of the firm is very high and there is no close substitute to its product because under these circumstances, the firm can fix high price for its product and can get abnormal profit.

This can be possible only in short-run because no new firm can enter into the market in short-run. This can be explained with the help of a diagram 1.

Quantity of Production

In the diagram, = E’ is the point of equilibrium of firm because at this point marginal cost and marginal revenue of the firm are equal. At this point, =OP‘ is the equilibrium price, =OQ‘ is the equilibrium quantity of production and sale, = PC‘ is the profit per unit. In this situation, the firm will earn abnormal profit equal to the area PSTC.

Normal Profit or Zero Profit

When demand of the product of a firm is not very high, the firm may get only the normal profit when average revenue is slightly more than average cost or zero profit when average revenue and average cost are equal. These situations can be illustrated with the help of diagram.

Quantity of Production a With Normal Situation of Profit

The diagram is the point of equilibrium of firm because at this point marginal cost and marginal revenue of the firm are equal. At this point, =OQ‘ is the equilibrium quantity, =OA‘ is the price per unit and =OD‘ is the cost per unit.

Here, average revenue is slightly more than average cost; in this case, the firm is getting profit equal to the area of =ABCD‘. In the diagram, = E‘ is the point of equilibrium of firm because at this marginal cost and marginal revenue of the firm are equal.

At this point, =OQ‘ is the equilibrium quantity, =OP1is the price per unit and = OP‘ is also the cost per unit. Here, average revenue and average cost are equal. Therefore, the firm is not making any profit or loss.

Loss

In short-run, a firm may have to suffer loss when demand of the product of firm is so weak that the firm has to sell its product at a price less than its cost, hi this case, average revenue of the firm is less than its average cost. It can be illustrated with the help of diagram.

In diagram 3.average revenue of the firm is less than its average cost. = E‘ is the point of equilibrium. At this point, = OQ‘ is the equilibrium quantity, = OD‘ is the price per unit and = OA‘ is the cost per unit. Here, price per unit is less than cost per unit. Therefore, the firm is suffering a loss equal to the area of‘ ABCD‘.

Long-term Equilibrium of a Firm

Long-term is the period in which a firm can adjust supply of its product according to its demand. New firms can also enter into the market in the period. Here, a firm always gets normal profit because if a firm is getting abnormal profit in short-term, new firms will enter into the market.

It will increase the supply of product and as a result, price of the product will decrease. This sequence of new firms entering into the market will continue until the firm comes in the position of getting normal profit only. On the contrary, if a firm is suffering loss in short-run, some firms will exit from the industry.

Now, supply of the product will decrease and price of the product will increase to the level of average cost or slightly above the average cost. Hence, firm will get normal profit. However, following two conditions should be satisfied for the equilibrium of a firm in the long run.

  • Marginal cost and marginal revenue of all the firms should be equal.

  • Average cost and average revenue of all the firms should be equal.

It can be illustrated with the help of diagram

Quantity of Production

In diagram, = E‘ is the point of equilibrium. At this point, MC = MR. At this point, = OM‘ is the equilibrium quantity, = OP‘ is the equilibrium price and = QM‘ is the average cost. At this point, average cost and average revenue are equal. It satisfies the conditions of normal profit. In this situation, the firm is getting normal profit equal to the area of PQRS).


FAQ

What is Monopolistic Competition?

Monopolistic competition is a situation of market in which the number of producers and sellers is large though not so large as to create the situation of perfect competition.
Thus, it is a compromise between perfect competition and monopoly. Under it, every producer and seller is a monopolist in his particular area due to product differentiation.

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