What is Monopolistic Competition?
Monopolistic competition is a market structure where companies offer the same type of product or services. In a monopolistic market, there is a combination of a competitive market and elements of monopoly. We can, therefore, say that it is the mid between the competitive and monopoly elements. There is freedom of entry and exit in a monopolistic competitive market, and one firms decision does not affect that of its competitors.
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How does Monopolistic Competition Work?
Most firms in a monopolistic market are similar but with a relatively low degree market power. It means that all of them are price makers, which makes the demand to be highly elastic, hence leading to high sensitive price changes. In monopolistic competition, there are positive economic profits, but in the short run. However, in the long run, it usually comes to zero. So, because of stiff competition, most firms engage in an intensive advertisement, so that they can be able to thrive in the market.
Examples of Monopolistic Competition
Generally, the monopolistic competition involves competition with a number of industries that consumers familiarize with every day. You can find this in real-world markets. Good examples of such include the following:
- Restaurants
Basically, differentiation of products is key when it comes to business. So, most restaurants competition always ranges from the quality of food, price as well as services. Also, there is free entry to this kind of business, meaning that there are low barriers when it comes to setting up a restaurant.
- Hair salons and barbershops
Hairdressing is also a good example of monopolistic competition. Salon and barbershop owners acquire a reputation based on the services they offer. Those with exceptional services usually build a good reputation, which attracts customers to their shops. Anyone is free to set up a hairdressing business because the business has low entry barriers.
- Clothing
Clothing is also another thing that people familiarize with during their day-to-day life. Product differentiation is also what makes this type of business to thrive in the clothing industry. For instance, designer label clothes thrive in the market because of the brand quality that makes it stand out from the rest.
- Television Programmes
Today we have many television programs ranging from local channels to international ones. People across the world are free to choose the programs they want to watch. For instance, Netflix provides consumers with a wide range of television programs from which they can choose from. Remember that content quality is what makes consumers prefer a certain channel over others.
Characteristics of a Monopolistic Competition
There are four features of monopolistic competition. They include the following:
- Product differentiation: Consumers always differentiate products based on design, quality, or service. So, in most cases, you may find similar products from different firms. However, because of the products element differentiation, another firms product or service, cannot be a perfect substitute for another company. There is always something that will make consumers like a product or service from a specific firm.
- The number of sellers: The manufacturing industries consist of various firms selling products that are closely related but are not similar. Most firms are usually independent and with limited market share. It means that one single firm cannot influence the market price.
- Perfect knowledge: Most consumers have little knowledge when it comes to differentiating quality brands and prices. So, most of them are not in a position to identify a seller with quality brand products that have low prices. So, most of them end up buying products of poor quality at a higher price and vice versa.
- Barriers to entry: When it comes to monopolistic competition, there are either minimal or no entry barriers. Minimal entry is an incentive for firms to enter the market hence increasing competition. Note that the firms will not necessarily be mobile, but they will bring about perfect competition, that will ensure that firms don't experience long-term supernormal profits.
- Marketing: Due to high competition in the market, each firm will want to advertise its product or service so that it is known to consumers. In other words, there is extensive marketing of products and services in a monopolistic competition.
- Demand Elasticity: There is a wide range of demand for similar products in the market. So, there is the tendency that the demand will bring changes to the prices in the market. For instance, lets assume that your favorite product A suddenly changes its price to $10 from its usual price of $7. In this case, you may be tempted to use an alternative product that costs low without your countertops knowing the difference.
Monopolistic Competition Assumptions
There are various assumptions when it comes to monopolistic competition. They include the following:
- In monopolistic competition, there are many consumers and producers who make industry competition ratio to be below.
- There is a perception by the consumers of there being a non-price differences among the products and services. In other words, the competition is strong, there is product differentiation, and most customers tend to switch from one product to the other.
- Producers can somehow control the prices in the market, as they are the price makers. However, there is price elasticity resulting from the high demand, which tends to be higher than that of monopoly.
- The barriers related to market entry and exit are relatively low.
Limitation of monopolistic Competition
- Some firms are able to penetrate the market and make supernormal profits because of their ability to produce a product with better brand differentiation.
- New firms entering the market are usually not seen as a close substitute. What this means is that it is difficult for their product or service to penetrate the already competitive market.
- Although the monopolistic model has the assumption that there are no entry barriers, in the real world, there are indeed several barriers related to market entry. For instance, a firm with strong product differentiation and strong brand loyalty is already a barrier. It means that it is difficult for new firms to penetrate the market and capture brand loyalty.
- The free barrier entry encourages new firms to enter the market. As a result, it reduces the demand for products from the existing firms bringing their profits from supernormal to normal.
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