Monopolistic competition combines features of both monopoly and perfect competition. An enterprise is a monopolist when it produces a particular kind of product that is different from other products on the market. However, the competition of monopolistic activity is created by many other firms that produce a similar, not completely identical product. 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 in the market when many manufacturing firms produce a product similar in purpose and characteristics, while being monopolists of a particular type of product.
The term was coined by American economist Edward Chamberlin in the 1930s.
An example of monopolistic competition is the shoe market. The customer may prefer a particular brandshoes for a variety of reasons: material, design or "hype". However, if the price of such shoes is excessively high, he can easily find an analogue. Such a restriction regulates the price of the product, which is a feature of perfect competition. The monopoly is provided by a recognizable design, patented production technologies, unique materials.
Services can also act as goods of monopolistic competition. Restaurants are a prime example. For example, fast food restaurants. They all offer roughly the same dishes, but the ingredients often differ. Often, such establishments strive to stand out with a branded sauce or drink, that is, to differentiate their product.
Market Features
The market of monopolistic competition is characterized by the following features:
- A large number of independent buyers and sellers interact on it.
- Almost anyone can start working in the industry, that is, the barriers to entry into the market are quite low and are more related to the legislative registration of production activities, obtaining licenses and patents.
- To compete successfully in the market, an enterprise needs to produce products that differ from the products of other firms in terms of properties and characteristics. This division can be either vertical or horizontal.
- When setting the price of a product, firms are not guided by either production costs or the reaction of competitors.
- Andproducers and buyers have information about the mechanisms of the market of monopolistic competition.
- Competition for the most part is non-price, that is, the competition of product characteristics. The company's marketing policy, in particular advertising and promotion, has a significant impact on the development of the industry.
A large number of manufacturers
Perfect and monopolistic competition is characterized by a sufficiently large number of producers in the market. If hundreds and thousands of independent sellers operate simultaneously in the market of perfect competition, then in a monopolistic market I offer several dozen firms. However, this number of manufacturers of the same type of goods is enough to create a he althy competitive environment. Such a market is protected from the possibility of collusion between sellers and artificial price increases with a decrease in production volumes. The competitive environment does not allow individual firms to influence the overall level of the market price.
Barriers to entry into the industry
Getting into the industry is relatively easy, but to successfully compete with established firms, you will have to make efforts to differentiate your product more, as well as to attract customers. Significant investment will require advertising and "promotion" of the new brand. Many buyers are conservative and trust a time-tested manufacturer more than a newcomer. This can hinder the process of going to market.
Product differentiation
Main Featuremonopolistic competitive market is the differentiation of products according to certain criteria. These can be real differences in the field of quality, composition, materials used, technology, design. Or imaginary, such as packaging, company image, trademark, advertising. Differentiation can be vertical or horizontal. In the process of making a purchase 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 product characteristics.
Differentiation is the main way a firm stands out and takes a place in the market. The main task: to determine your competitive advantage, target audience and set an acceptable price for it. Marketing tools help promote products in the market and increase brand value.
With this market structure, both large manufacturers and small enterprises focused on working 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, price changes have little effect on the volume of sales. Under such conditions, firms are forced to resort to non-price methods of competition:
- make more effort to differentiate the physical properties of their products;
- provide additional services (for example, after-sales service for equipment);
- attract customers through marketing tools (original packaging, promotions).
Profit maximization in the short run
In the short run model, one factor of production is fixed in terms of cost, while the other elements are variable. The most common example of this is the production of a good requiring manufacturing capacity. If the demand is strong, in the short term, only the amount of goods that the factory capacity allows can be obtained. This is due to the fact that it takes a significant amount of time to create or acquire a new production. With good demand and an increase in price, it is possible to reduce production at the plant, but still have to pay for the cost of maintaining the production and the associated rent or debt associated with the acquisition of the enterprise.
Suppliers in monopolistic competitive markets are price leaders and will behave similarly in the short term. Just as in a monopoly, a firm will maximize its profit by producing goods as long as its marginal revenue equals its marginal cost. The profit maximization price will be determined based on where the maximum profit falls on the average revenue curve. Profit -is the sum of the product multiplied by the difference between the price minus the average cost of producing the good.
As you can see from the graph, the firm will produce the quantity (Q1) where the marginal cost (MC) curve intersects with the marginal revenue (MR) curve. The price is set based on where Q1 falls on the average revenue (AR) curve. The firm's short-term profit is represented by the gray box or quantity times the difference between the price and the average cost of producing the good.
Because monopolistically competitive firms have market power, they will produce less and charge more than a perfectly competitive firm. This results in a loss of efficiency for society, but from a producer's point of view, desirable because it allows them to make a profit and increase the producer's surplus.
Profit maximization in the long run
In the long-term model, all aspects of production are variable and therefore can be adjusted for changes in demand.
While a monopolistic competitive firm may make a profit in the short run, its monopoly price effect will reduce demand in the long run. This increases the need for firms to differentiate their products, leading to an increase in the average total cost. A decrease in demand and an increase in cost causes the long-run average cost curve to become tangent to the demand curve at the profit-maximizing price. This means two things. First, that firms in a monopolistic competitive market will eventually incur losses. Secondly, the firm will not be able to make a profit even in the long run.
In the long run, a firm in a monopolistic competitive market will produce the quantity of goods where the long-run cost (MC) curve crosses marginal revenue (MR). The price will be set where the quantity produced falls on the average income (AR) curve. As a result, the firm will suffer losses in the long run.
Efficiency
Due to product diversification, the firm has a kind of monopoly on a particular version of the product. This is where monopoly and monopolistic competition are similar. 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 it creates conditions for greater diversification of the product. In most cases, monopolistic competition is favored by society because, with a variety of similar but not exactly identical products, everyone can choose a product according to their individual preferences.
Benefits
- There are no serious barriers to entry into the market. The opportunity to make a profit in the short term attracts new producers, whichforces old firms to work on the product and apply additional measures to stimulate demand.
- Variety of similar but not exactly identical products. Each consumer can choose a product according to personal preferences.
- Monopolistic competition market is more efficient than monopoly, but less efficient than perfect competition. However, in a dynamic perspective, it encourages manufacturers and retailers to use innovative technologies to maintain market share. From the point of view of society, progress is good.
Flaws
- Significant advertising costs that are built into the cost of production.
- Under capacity utilization.
- Inefficient use of resources.
- Manufacturers' deceptive maneuvers that create ostensible product differentiation that mislead consumers and create unreasonable demand.
Monopolistic competition is a market structure in which there are several dozen manufacturers of a similar, but not absolutely identical, product on the market. This market structure combines features of both monopoly and perfect competition. The main condition for monopolistic competition is product diversification. The firm has a monopoly on a particular version of the product and may overprice, creating an artificial scarcity of the product. This approach encourages firms to use new technologies in production in order to remain competitive in the market. However, this market modelcontributes to overcapacity, inefficient use of resources and rising advertising costs.
