Question

What is meant by monopolistic competition? What are the characteristics of this market type? What does equilibrium imply with monopolistic competition? What are the advantages/disadvantages of this market type?

Answer 1

A Monopolistic competition is an imperfect competition in which there is large number of buyers and sellers but not as large as in perfect competition selling differentiated goods. The goods differ in shape, taste, quality, etc, the goods are not perfect substitutes.

Features/ Characteristic of Monopolistic Competition:

• Product Differentiation: The goods are not perfect substitutes in the sense that, the goods differs in shape, quality, taste, etc.
• Many firms: There are many firms in the industry but not as large in the case of perfect competition.
• Imperfect information: The buyers and sellers do not have perfect information about the product sold and the price level in the industry.
• Firms are price takers: The firm decides their own price charged on goods and services.

Equilibrium condition for a monopolist: The profit maximization condition is: Marginal Revenue = Marginal Cost

The advantages of monopolistic competition:

• More competition is better for the industry as it does not gives single seller the right to supply the good.
• Better for buyers because the monopolistic competition allow many firms to enter in the industry which raises the market supply.
• Differentiated goods are being sold in the market which promotes innovation.

The disadvantages of monopolistic competition:

• Due to differentiated goods, the firms can select their own price level.
• Spends too much on advertisement which increases their cost and born by consumers.
• They add irrelevant features to their product in order to differentiate it with other product but forget to improve the basic product.