Note on
Monopolistic Competition
Monopolistic Competition-Monopolistic Competition is that condition of market in which
there are many sellers of any commodity but commodity of every seller is different from
commodities of other sellers in any way. Therefore, product differentiation is main quality of
monopolistic competition.
Characteristics of Monopolistic Competition
Following are the main characteristics of Monopolistic Competition—
1.Large Number of Firms and Buyers: Firm producing differentiated product and sellers are
large in numbers in monopolistic competition.
2. Product Differentiation: Product differentiation is the main feature of monopolistic
competition. Product differentiation means that product of different types, brands, and qualities
will be available to customers in a fixed time period. Product differentiation occurs when buyer
of product can differentiate between two products. In this, firms are in large number but their
products are different from each other in anyway, but these products are close substitutes of
each other. Product differentiation is obtained due to characteristic of product like shape,
measurement, colour, durability, quality etc. There are many examples of product
differentiation like bath soaps Lux, Godrej, Camay, Rexona, etc.
3. Freedom of Entry and Exit of Firms: In the situation of monopolistic competition there is
freedom of entry and exit of firms in the industry like perfect competition. It should be noticed
that Chamberlin has used group at the place of industry for group of firms which produce
differentiated products under the monopolistic competition.
4. Selling Cost: An important characteristic of monopolistic competition is that every firm
spends more money in promoting its product under it. Firm gives advertisements in
newspapers, cinemas, magazines, radio, T.V. etc. for selling its product in the maximum
amount. The investment done on all these is called as Selling Costs.
5. Price Control: Every firm has limited control on the cost of product. Average income and
limit end income curve of a firm fall down like monopoly in monopolistic competition. It
means that in this situation, firm can slow down the price for selling more products and raise
price for fewer products. In monopolistic competition, a firm has control on cost of its
production due to the product differentiation. But due to the availability of close substitute of
opposite product firms do not have full control on cost in monopolistic competition. The cost
of every firm is affected by cost policy of its competitors in market up to the certain limit.
6. Limited Mobility: In monopolistic competition, sources of production and products and do
not have mobility in services.
7. Imperfect Knowledge: In the situation of monopolistic competition, buyers, sellers of
products, and owners of sources do not have knowledge of different prices of product. The
reason is that comparison between productions of different firms is not possible due to product
differentiation. Customers are fond of the production of any one specific firm. They only buy
the production of that firm even if it costs higher than others. In this way even sources of
production are not able to know fully that how much the different firms are costing to the
sources of services.
8. Non-Price Competition: The main characteristic of monopolistic competition is that under
it different firms without changing the costs of products compete with each other like the
example of companies producing ‘Surf’ and ‘Ariel’. If you take a box of ‘Surf’, you will get a
glass utensil similarly, with the box of ‘Ariel’ you will get the steel spoon. In this way, firms,
by providing different types of facilities and products etc. to customers to attracts them toward
their products. This type of competition is called as Non-Price Competition.
Equilibrium Under Monopolistic Competition
In the situation of monopolistic competition, if any firm wants to sell maximum quantity of its
production then it has to decrease the cost. That’s why, in the situation of monopolistic
competition, Average Revenue Curve (AR Curve) and Marginal Revenue (MR Curve) fall
down in the form of left to right. In monopolistic competition, a firm produce till the point or
limit at which (i) Marginal Revenue is equal to Marginal Cost (MR = MC) and (ii) Marginal
Revenue Curve cuts Marginal Cost Curve from the lower side. In this situation firm is in the
condition of balancing by the production. The study of equilibrium firm in monopolistic
competition can be done in two different durations—
(1) Short Run and (2) Long Run
Short Run Equilibrium in Monopolistic Competition
Short Run is that duration of time in which production can be increased only by increase in
using variable resources on increasing demand. There is no time to increase or decrease
constant resources of production like machine, plant, building, etc. In short run, an equilibrium
of a firm will be in that situation in which (1) MC = MR and (2) MC curve will be cutting MR
curve. There can be three conditions of firms in this duration of time—
(1) Super Normal Profits, (2) Normal Profits and (3) Minimum Losses.
Super Normal Profits-Firm is in equilibrium at point E because marginal cost and marginal
revenue are equal (MR = MC) on point E and MC curve cut MR curve from the lower side. It
is known by point E that OM will be equilibrium production of firm. The cost of equilibrium
production is OC (= AM). The cost (AM) of equilibrium production will be less (AM ˂ BM)
than average Revenue BM so every unit of firm is obtained Super Normal Profits BM – AM =
AB. Firm has total super normal profit ABCP.
MC
AC
Y Super Normal
Profit
B
P
C A AR
Cost & Revenue E
MR
O M X
Output
Normal Profits: In short-run, firm of monopolistic competition can have the normal profits.
firm will be in equilibrium situation at point E because at point E (i) MC = MR and (ii) MC
curve cuts MR from the lower side. It is known by point E that OM will be the equilibrium
production. The cost of equilibrium production is OP (AM) and average cost is also OP (AM).
The reason is that AR curve is touching AC curve at point A. That’s why in the situation of
equilibrium cost (AR) and average cost (AC) are equal (AR = AC). Therefore, only normal
profits will obtain to firm.
MC
Y Normal Profit
AC
P B
Cost & Revenue E
AR
MR
O M X
Output
Minimum Loss: Firm can also have loss of fixed cost in short-run. This is the minimum loss
of firm. Firm will be in equilibrium at point E. At this point, MC = MR and MC curve cuts MR
curve from the lower side. In the equilibrium condition, firm will produce OM. The cost of
equilibrium quantity OM is OP (= BM) and average cost OP1 (= NM). A short-run average
cost of firm more than (SAC > AR). So firm will have per unit loss of NM – BM = BN. Total
loss of firm will be the area of NBPP1.
MC
Y Loss
N AC
P1
P B
Cost & Revenue E
AR
MR
O M X
Output
Long-Run Equilibrium in Monopolistic Competition
Long-term is that duration of time in which firms can change level of their plants, new firms
can enter into the market and old firms can leave the market. It should be kept in mind that
products differentiated in monopolistic competition are not similar. Chamberlin had used
the word product group at the place of industry to those firms which produce differentiated
product.
MC LMC
Y Normal Profit
LAC
P B
AR
Cost & Revenue E
MR
O M X
Output
In Figure LAC is long-run average cost curve and LMC is long-run marginal curve. AR is lead
average and MR is marginal lead curve. MR and MC at point E are equal to each other.
Therefore, it will be equilibrium point. OM will be produced on this point, which costs
OP(=AM). Average revenue curve on equilibrium production OM is touching long-run average
cost curve at point A. So, in the equilibrium condition, cost and long-run average cost (AR =
LAC) are equal to each other. Therefore, firms are earning only normal profits. There will be
maximum profits of LAC and AR at ‘A’, Point of Tangency. The reason is that on any other
cost average cost (AC) is more than average revenue (AR) of long-run average cost curve (AR)
so firm will incur loss. Due to the normal profits obtained by the firm, there will be no
encouragement for the entry of new firms in the group and no reason for exit of old firms from
the group.
