MONOPOLISTIC COMPETITION

Monopolistic competition refers to a market situation in which there are large number of firms which sell
closely related but differentiated products. Markets of products like soap, toothpaste, AC, etc. are examples
of monopolistic competition”.

Features of Monopolistic Competition

(ii) Free entry or exit of firms : Firms are free to enter the industry or leave it. However, new firms have no
absolute freedom of entry into industry. Products of some firms may be legally patented. New firms cannot
produce those products, e.g. no rival firm can produce or sell a patented item like Woodland shoes.

1. Many Sellers:

The numbers of firms under monopolistic competition are fairly large, though, it is not as large as found
under perfect competition. Each firm shall be a small sized firm controlling only a small part of the total
market. Thus, each seller can take decisions more or less independently without worrying about the
reactions of other sellers. Greater is the number of firms in the market, the more elastic the demand curve
would be and vice versa.

2. Product Differentiation:

Product differentiation is one of the most distinguishing features of monopolistic competition. Differentiation
may be based upon certain characteristics of the product itself, such as exclusive patented features,
trademarks, trade names, peculiarities of the package or container, if any or singularity in quality, design,
colour or style. It may also exist with respect to the conditions surrounding its sale. The differentiated
products are close substitutes of each other like Colgate and closeup toothpaste.
Because of product differentiation, each firm can influence its price. So that, each firm has a partial control
over price of its product.

3. Sales Promotion or Selling Cost:

Advertising and other selling expenses have an important role under monopolistic competition on account
of imperfect knowledge on the part of buyers. Advertising broadens the market and encourages
competition.

Salesmen salaries, other expenses of sales department, window displays and different types of
demonstrations are some examples of selling expenses. Advertisement plays an important role in creating
imperfections in the market.

Advertisement may, however, be broadly classified as promotional advertisement and competitive

4. Demand Curves:

The product differentiation and sales promotion increase the demand of the product in question and make it
more inelastic, creating opportunities for increasing profit earnings. The greater the product differentiation,
the more inelastic will be the firm’s demand curve.

However, the demand curve of a monopolistically competitive firm is more elastic (i.e., less steep) than the
demand or average revenue curve of a monopoly firm. The reason is that the product of the firm under
monopolistic competition has close substitutes available in the market, while the product of the monopoly
firm has no substitutes available in the market.
5. Free Entry and Exit:

Under monopolistic competition, there is freedom of entry and exit of the firms in the long run. New firms
enter the group, when the existing firms earn super normal profits by differentiating their products. This will
result in a decrease in the demand of existing products at least to some extent and or an increase in the
cost.

6. Other Characteristics:

(i) The goal of the firm is profit maximisation both in the short-run as well as in the long-run.

(ii) The prices of factor inputs and technology are given.

(iii) The firm is assumed to behave as if it possessed information regarding the demand and cost curves
with certainty.

Short-run equilibrium of the firm under monopolistic competition.

The firm maximizes its profits and produces a quantity where the firm's marginal revenue (MR) is equal to
its marginal cost (MC). The firm is able to collect a price based on the average revenue (AR) curve. The
difference between the firm's average revenue and average cost, multiplied by the quantity sold (Qs), gives
the total profit.

Long-run equilibrium of the firm under monopolistic competition

. In the long run the firm still produces the amount of goods where marginal cost (LMRC) and marginal
revenue (MR) are equal. The price will be set where the quantity produced falls on the Average revenue
(AR) curve. The firm as a result operates on break even.
Problems with Monopolistic Competition

Monopolistic competition fosters advertising and the creation of brand names. Advertising induces
customers into spending more on products because of the name associated with them rather than because
of rational factors. Defenders of advertising dispute this, arguing that brand names can represent a
guarantee of quality. There are unique information and information processing costs associated with
selecting a brand in a monopolistically competitive environment.
In a monopolistically competitive market, the consumer must collect and process information on a large
number of different brands to be able to select the best of them. In many cases, the cost of gathering
information necessary to selecting the best brand can exceed the benefit of consuming the best brand
instead of a randomly selected brand. The result is that the consumer is confused. Some brands gain
prestige value and can extract an additional price for that.
Case study: Hindustan Unilever Limited is the largest FMCG Company with market leadership in the Soaps &
Detergents Industry. Find out the evolution of HUL as the market leader in light of the Life Cycle of a Firm and
how it managed to sustain its position with emerging new entrants in a monopolistic competitive market.