Revision - Monopolistic Competition

Monopolistic competition is a form of imperfect competition and can be found in many real world markets ranging from clusters of sandwich bars and coffee stores in a busy town centre to pizza delivery businesses in a city or hairdressers in a local area. Small-scale children’s nurseries and care homes for older people might also fit into the market structure known as monopolistic competition.

The assumptions of monopolistic competition are as follows - as you check through them look to see the differences between this mark structure and perfect competition.

1. There are many producers and many consumers in a market - the concentration ratio is low
2.Consumers perceive that there are non-price differences among the competitors’ products i.e. there is product differentiation
3. Producers have some control over price - they are “price makers” rather than “price takers.”
4. The barriers to entry and exit into and out of the market are low

In the short run the profits made by businesses competing in this type of market structure can be at any level. One of the predictions of the model is that high levels of abnormal profit will attract new suppliers and new products into the market the effect of which might be to reduce the demand for existing products and reduce profits down towards normal profit equilibrium.

Strong brand loyalty can have the effect of making demand less sensitive to price.

The long run equilibrium may be reached with normal profits being made. The reality is that a stable equilibrium is never reached - new products come and go all of the time, some do better than others. Existing products within a market will typically go through a product life cycle which affects the volume and growth of sales.

One of the possible implications of monopolistic competition is that an inefficient outcome is reached. Prices are above marginal cost and saturation of the market may lead to businesses being unable to exploit fully the internal economies of scale - causing average cost to be higher than if the market was being supplied by less firms and products. Critics of heavy spending on marketing and advertising argue that much of this spending is wasted and is an inefficient use of scarce resources. The debate over the environmental impact of packaging is linked strongly to this aspect of monopolistic competition.