Question

True or false?

One reason that “monopolistic competition” under the neoclassical paradigm might be a more representative model of the real world than that of “perfect competition” is that the assumption of differentiated products allows for historically-created brand loyalty.

Answer 1

This is true.

A monopolistically competition is defined as a market structure which consists of a large number of firms which produces similar but "differentiated" producs. In other words, these products are similar to each other but not completely identical because they are differentiated on the basis of packaging, brand, flavor and so on.

If you try to contrast this with a perfectly competitive market, we will find that it's very restrictive in its assumption. It claims to be a market structure where there are large numbe of buyers and sellers and the products are completely identical. No firms can charge a price greater than the marginal cost and they all earn zero profits in the long run.

Perfect competition is very unrealistic and can be only theoretically possible. You see, firstly, you can NEVER have identical products because every product albeit similar WILL differ in some way or the other. You may have a different variety, or a new generation product or it might be from a specific brand.

People often choose brands because they believe that the brand would deliver the quality that they are desiring for. As a result, the concept of "differentiated products" can include this dimesion because brands is a way to differentiate a product.

You can have a shoe with the same design from a local store or can buy a branded one from Reebok. But the shoe is a shoe. The only thing which differs is the brand. The Reebok shoe adds the brand in it's value which significantly increases the price. The consumer is ready to pay this price because she is brand loyal.

These small changes are the way products are differentiated in real life.

Hence, we can claim that monopolistic competition is in a position to describe the reality better than that of a perfectly competitive market structure in the sense that the former allows for the inclusion of differentiated products in the markets. Brands can be a major factor in differentiating the products as there are always some brand loyal consumers who will be there to buy it.