Monopolistic Competition – Principles of Microeconomics

The term “monopolistic competition” was coined by the economist A.W.B. Phillips (1891–1976). In a perfectly competitive and monopolistic industry, a product’s price is set by the industry’s cost of production. With a monopoly, a firm sets prices that are the same for the products it makes. Thus a firm that makes two differentiated products does not set the price for each product individually. Instead, it establishes prices that are equal for the two products, and these prices are set by an appropriate rule.

Monopolistic competition arises when there are many producers, all offering a good or service characterized as distinct from one another.

Competition amongst those producers is at a minimum due to the high barriers of entry to the industry and the inability of producers to engage with one another through mergers and other forms of interdependence. Monopoly power (the ability to set prices at any level) arises when a firm is large enough to exert significant market power over prices.

The absence of competition allows a single firm to use pricing power to gain an advantage over competitor firms in output and profit. While the competitive market is characterized by prices being a reflection of the “cost” of producing, a single firm in the context of monopoly will only need a profit margin, which is the difference between the product cost and the price of the product to break even.

Monopolistic competition characteristics.

  • In a perfectly competitive industry, production is characterized by constant and competitive conditions, and a wide and dynamic array of firms offering a variety of options that are similar to in the competitive market
  • In a monopolistic industry, production is characterized by high barriers of entry and strong exclusion, firms are characterized by their particular products
  • There are no significant changes in industry characteristics with respect to price and output levels to offset the differences between monopolistic industry and competitive market.
  • In a monopolistic competitive market there are a large number of sellers in the market, all competing for the same customers.
  • There are alot of differentiated products from different sellers and competitors in the market.
  • There exists some control over price of some of the products and services.
  • There is an easy entry and exit in the market since there is low barriers to entry.
  • There is little advertisment going on in the market, and other non price competitions.
Organized entreprenuer monopolistic competition characteristics infographics

Monopolistic competition market structure.

  • In competitive firms, it is usual to observe that there is price competition between firms.
  • Firms make their price based on the lowest unit cost of production.
  • Firms are not price-sensitive because they are not competing with one another.

The competition will occur between them in the following case when both firms produce the same products:

  • Firm 1 – lower cost Product – higher profit (if all else is the same)
  • Firm 2 – higher cost Product – lower profit (if all else is the same)
  • Monopolistic industry – Monopolistic firm sets the price

Monopolistic competition control over price.

A firm is said to have monopoly power if it dominates the relevant market. (When the firm with monopoly power also has market power, it is said to have market power).

In a competitive market, there is no control over the price of products. The price which emerges from the competitive market is determined by the consumers’ preferences, which are based on market forces.

In the monopolistic industry, one of the most significant price-setting mechanisms is known as the “monopoly price”. One could call the monopoly price the “most efficient price” because it is set at a level at which the profits from market-making are maximized by the monopolistic firm.

The monopoly price must be below that of the price being set by the competitive market and this is usually the result of the monopolist’s decision to charge a price below the competitive price to the public.

Monopolistic competition advantages and disadvantages.

Advantages are:

  • Economies of scale: The gains from size increase more quickly in a competitive market than in a monopolistic one.
  • Ability to exploit consumers’ preference for differentiated products
  • Customers of large and profitable firms can afford better quality and service because there is more demand on firms to produce according to their needs and that has not changed in the market.
  • The monopolistic competitor has higher earnings (profits) than a competitor in a competitive market.
  • The price of the product increases as the industry grows in size.
  • Monopolistic competition is the prevailing scenario in markets.
  • If one observes a product that is offered at no cost, a product that is offered with minimal cost, and a product that is priced much higher than another product, then that product is monopolized.

Disadvantages are:

  • The price-setting mechanism becomes less flexible and less responsive to market conditions.
  • Market outcomes (price, quantity) are not as dynamic as in a competitive market.

Monopolistic competition long run.

The long-run in a monopolistic market is a period when there is less uncertainty as there is no change in the industry or the environment. The long-run refers to the period in which the firm holds a monopoly over the market.

Monopolistic  Competition Long-Run Equilibrium infographics

In the long run, only one firm will survive i.e. the winner takes it all. It is possible to predict the winner in long run in a monopoly market.

Monopolistic competition short run.

The short-run in a monopolistic market is a period when there is a change in the industry or in the market. The environment is changing, therefore, there is uncertainty in the short-run period.

Monopolistic  Competition short-run profit vs short-run loss infographics

A monopolist has a large probability of surviving for the long term; but, it has a small probability of surviving for the short term. The winner of the short run is not known.

Monopolistic Competition Market Entry Strategy.

In the case of a monopolistic firm, there is no competition between firms. So, there are fewer options available for the user and hence high monopoly prices. The monopoly price is the one that is decided by the competition among firms. Loss of profit is due to competition among buyers and sellers.

This has to be a product that is more expensive, more effective, or unique than a product offered by the already existing monopolistic firms. Therefore, the only way a new firm can enter the market is to produce a unique product.

There are three main factors that affect the decision to enter a Monopolistic Competition Market as a new operator:

  1. High price per unit and quality
  2. Product Uniqueness and Efficiency – Attractiveness of Products.
  3. Uniqueness and Quality of products and services.
  4. Size of products

Size of products

  1. Large size can make production efficient and fast.
  2. The larger size can also provide service to more customers.
  3. The larger sizes can lead to better infrastructure that can meet the needs of its customers.

Monopolistic competition assumptions.

  • Uncorrelatedness of inputs and demand
  • Product differentiation
  • The demand for products is the function of price.
  • A monopolist can increase supply because there is no need to be concerned about the price the price is set by the competition and there is no need to be concerned either about the price being set by its competitors
  • Product uniqueness plays an important role and is perceived to be more desirable or unique, product perception will help the firm to sell more.

Monopolistic competition product differentiation.

Product differentiation plays an important role in a monopolistic market. The more attractive a product or service is, the faster one can capture the customers.

Each business produces a product that is slightly different from each other and the business face a downward sloping demand for its products curve.

The following are some of the forms businesses take to differentiate their products from competitors in a monopolistic market:

  1. Differentiation by size and style.
  2. Differentiation by location.
  3. Differentiation by quality.

Product diversification can increase the firm’s profit because:

  • The company can have a variety of products.
  • It helps to build a reputation and maintain the quality of services offered.
  • A successful diversification can help to produce new products and services.

However, the cost of diversification can be very high, because a diversification firm usually increases operating costs.

Monopolistic competition dynamics and strategies.

The monopoly in monopolistic competition is dynamic, that is, it changes over time. Monopolists can use the resources, for example, production capital and the size of firms, to change the equilibrium outcomes of the monopolist.

The monopolistic profit comes from the price it charges and/ or the volume it sells, whereas the competitive market depends on profit and it is maximized.

There is ‘monopoly profit’, which is higher than that of the competition. It is an economic term, which means gaining more profit from a single unit that is sold.

Monopolistic competition advertising.

  1. A monopoly firm is like a monopoly firm in the market for providing a service; what they do is charge more for a service offered earlier. What they do is to charge something higher than the price being set in a competitive market.
  2. Monopolists in a market are most effective in competing with the large and existing monopolies, that is, to compete with those firms, there must be a sufficient reason to switch because once switching between the monopolist’s products/services, the firm will immediately lose all its benefits.
  3. Perfectly competitive firms in the market dont have a luxury to advertise in the makret, the only advertisers are monopoilistic competitors.
  4. There exists only one goals in monopolistic advertisement and that is to increase products and services demand and supply and make them more inelastic.
  5. If there is an increase of products and services costs in a momopolistically market, the cost is know ans “differentness”.

Monopolistic competition product differentiation examples.

A monopolist can differentiate the product by creating a product that has fewer, or greater, attributes (i.e., by adding extra cost, or using some means to reduce the price), than a competitive product.

Monopolistic competition product differentiation examples.

Example 1:

You are a new start-up firm, you have a good and better product/ service but you cannot differentiate it, because your competitors don’t have lower prices. You need more customers so the only way to distinguish your product is to lower your prices, and so, your company becomes a monopolist.

Example 2:

A monopolist starts producing a product that sells for a much higher price than the price of competitors. This new firm is differentiated from the existing monopolists not only because it sells at a higher price, but because it also sells a better quality product.

Example 3:

In a monopolistic market, firms may have a large amount of capital which the firm can use when investing money into the product. It may also have access to a higher degree of automation. Firms may also use less labor or use different types of marketing tools. Firms use this capacity when it comes to their decision to change the product, the quality of the product, and the cost.

Monopolistic competition management.

A firm’s profit, which is the number of profits that can be earned when it sells the right amount of product, is a good indicator for the company’s management of the firm. When the firm’s profit is low, there may be problems in the company. If there have been changes in this number, if there is a decrease, it can probably be because it is producing an inferior product.

monopolistic competition management

Frequently Asked Questions.

Monopolistic competition Vs Monopoly.

Monopolistic Competition: The competitive market is the market where many products compete at the given price, that is, there is no ‘pricing authority’. This means that monopolistic firms are the ones who set the price in the market.
Monopoly: when a firm has no competition, there is a high profit. Because there is competition in the market, the firm becomes the ‘price setter’ in the market. The firm has more profits because it profits based on price increases.

To profit, a firm needs to have a monopoly. If the firm wants to survive, it must follow the strategy of setting a higher price. Monopoly is the most widely recognized and used form of competition. It is characterized by a single producer (monopolist) that sets prices that are much higher than competitors and therefore produces very high profits.

Monopolistic competition Vs Perfect Competition.

Monopolistic competition: the competitive market is the market where firms interact to sell similar products. They set the price for their products but they are not the ‘price setters’ in the market. In the market, there will be no monopoly firms; in the market, there is competition between firms.
Perfect competition:  There is only one firm in the market, and the firms have no relationship with one another. They sell exactly the same product in the market and are differentiated only from the quality of quality attributes, they have.

Monopolistic competition Vs Oligopoly.

Monopolistic Competition:  All the firms have an economic relationship with one another, and they are selling similar products in the market. There are barriers to entry in the market to the extent that there is price control of the product in the market.
Oligopoly Competition:  There are many firms in the market, but these are not competing in the market. There is price control on the product or there is quality control by the firms.

What company is an example of monopolistic competition?

Many companies are examples of monopolistic competition. When the market is competitive, there is competition among many sellers. The market is not monopolistic in this case. When the market is monopolistic, there is only one seller. There is no competition. Monopolistic competition is common in markets with low barriers to entry. Examples include the airline, cable, and publishing industries.

An example of monopolistic competition is when a company has only one or a small number of sellers.

What is a monopolistic example?

A monopolistic example is a company with an absolute monopoly on the market. The term comes from the word monopoly, meaning one person or business has all the power in the market. A good example of this is Microsoft. They are the most popular operating system for computers. The company has had a monopoly for a long time. Most people don’t even realize that there are other operating systems.

What are the four conditions for monopolistic competition? 

Monopolistic competition occurs when a firm has a significant market share and cannot profit from its share. It can influence prices and quality. It is important to note that the firm is not a monopoly and is not a duopoly.

A firm with a significant share of the market and cannot profit from its share is called a monopolist. Monopolists can influence prices and quality. A firm is not a monopoly if it does not have a significant market share and cannot profit from its share.

The conditions for the monopolistic competition are: (1) there are not many firms, (2) there are few firms that compete for the same product, (3) there are few buyers, and (4) there is some degree of product differentiation

Which is a characteristic of monopolistic competition?

Monopolistic competition is a market structure where a single seller can set prices. In such cases, the seller has all the necessary information to set prices and can benefit from keeping prices low instead of a free market.

Monopolistic competition is a type of competition where only a few firms are left in the market. Monopoly is not the only characteristic of monopolistic competition. The firms tend to be the same or similar to each other. For example, if a bank has monopoly powers over a particular area, it will be the same bank that operates in the same city throughout.

Firms in monopolistic competition are similar in one main respect – they are often more costly to consumers than their non-monopolistic counterparts. These costs, however, are passed on to consumers.

What is the best example of monopolistic competition?

A monopolistic industry is where just a handful of companies compete to sell a product or service. Examples of monopolistic industries are airlines, banking, fast food, and the movie industry.

What does monopolistic competition have in common with a monopoly?

Monopolistic competition is a business model that offers a unique product or service. The most common example of this is the telephone company. In monopolistic competition, a business competes against one or more other businesses offering the same product or service.

Both monopolistic competition and monopoly are highly competitive situations resulting in a single product or service supplier.

James Ndungu

James is a one-on-one business consultant who helps CEOs, executives, and solopreneurs build their personal and professional branding.

Recent Posts