Page 183 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes Each firm is, therefore, the sole producer of a particular brand or “product”. It is a monopolist as

far as that particular brand is concerned. However, since the various brands are close substitutes,
a large number of “monopoly” producers of these brands are involved in keen competition with
one another. This type of market structure, where there is competition among a large number of
“monopolists” is called monopolistic competition.
The differentiation among competing products or brands may be based on real or imaginary
differences in quality. Real differences among brands refer to palpable differences in quality

such as shape, flavour, colour, packing, after sales service, warranty period, etc. In contrast,
imaginary differences mean quality differences which are not really palpable but buyers are
made to imagine or are “conditioned” to believe that such differences exist and are important.
Advertising often has the effect of making buyers imagine or believe that the advertised brand

has different qualities. When there is product differentiation, each firm has some degree of
control over price.
As a result, under monopolistic competition, the demand or average revenue curve of an

individual firm is a gradually falling curve. It is highly elastic but not perfectly so. Therefore,

the marginal revenue curve of the firm is also falling and lies below the average revenue curve
at all levels of output. It is in this respect that monopolistic competition differs from perfect
competition.
In addition to product differentiation, the other three basic characteristics of monopolistic
competition are:

1. There are a large number of independent sellers (and buyers) in the market.
2. The relative (proportionate) market shares of all sellers are insignificant and more or less

equal. That is, seller concentration in the market is almost non existent.
3. There are neither any legal nor any economic barriers against the entry of new fi rms into
the market. New firms are free to enter the market and existing firms are free to leave the

market.
In other words, product differentiation is the only characteristic that distinguishes monopolistic
competition from perfect competition.
Firms selling slightly differentiated products under different brand names compete not only
through variations in price but also through variations in product quality (product variation)
and changes in advertising or selling costs. Thus, under monopolistic competition, an individual

firm has to maximise profits in relation to variations in three policy variables, namely, price,
product quality, and selling costs. (In contrast, under perfect competition there is competition
only through price variation).
Example: We find many examples of monopolistic competition in real world. The best

examples can be found in retail trade. As we know the main characteristics for this type of market
situation is that there are many producers and many customers for the services/products, yet
no company has control over the market price, consumers understand that there are non-price
differences among the competitors’ products, and there are very few barriers to enter and exit
from the market.
Food and Beverage (Restaurant) industry is an example of monopolistic competition, especially
in the fast food industry in which all services are basically the same, but are marketed differently,
and there exists a perception that some fast food restaurants must be better than others.
Toothpaste and soap manufacturers often engage in monopolistic competition practices. Rather
than changing the products themselves, producers change the packaging, the design, or simply
claim through advertising that their product is best.

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