What is Monopolistic Competition ?

Its Meaning

Pure monopoly and perfect competition are two extreme cases of market structure. In reality, there are markets having large number of producers competing with each other in order to sell their product in the market. Thus, there is monopoly on one hand and perfect competition on other hand. Such a mixture of monopoly and perfect competition is called as monopolistic competition. It is a case of imperfect competition. Monopolistic competition has been introduced by American economist Prof. Edward Chamberlin, in his book 'Theory of Monopolistic Competition' published in 1933.

Features of Monopolistic Competition

The following are the features or characteristics of monopolistic competition :-

1. Large Number of Sellers

There are large number of sellers producing differentiated products. So, competition among them is very keen. Since number of sellers is large, each seller produces a very small part of market supply. So no seller is in a position to control price of product. Every firm is limited in its size.

2. Product Differentiation

It is one of the most important features of monopolistic competition. In perfect competition, products are homogeneous in nature. On the contrary, here, every producer tries to keep his product dissimilar than his rival's product in order to maintain his separate identity. This boosts up the competition in market. So, every firm acquires some monopoly power.

3. Freedom of Entry and Exit

This feature leads to stiff competition in market. Free entry into the market enables new firms to come with close substitutes. Free entry or exit maintains normal profit in the market for a longer span of time.

4. Selling Cost

It is a unique feature of monopolistic competition. In such type of market, due to product differentiation, every firm has to incur some additional expenditure in the form of selling cost. This cost includes sales promotion expenses, advertisement expenses, salaries of marketing staff, etc. But on account of homogeneous product in perfect competition and zero competition in monopoly, selling cost does not exist there.

5. Absence of Interdependence

Large numbers of firms are different in their size. Each firm has its own production and marketing policy. So no firm is influenced by other firm. All are independent.

6. Two Dimensional Competition

Monopolistic competition has two types of competition aspects viz. i. ii. Price competition i.e. firms compete with each other on the basis of price. Non price competition i.e. firms compete on the basis of brand, product quality advertisement.

7. Concept of Group

In place of Marshallian concept of industry, Chamberlin introduced the concept of Group under monopolistic competition. An industry means a number of firms producing identical product. A group means a number of firms producing differentiated products which are closely related.

8. Falling Demand Curve

In monopolistic competition, a firm is facing downward sloping demand curve i.e. elastic demand curve. It means one can sell more at lower price and vice versa. Given below are some examples of monopoly, monopolistic competition and oligopoly in India. Monopoly

Indian Railways has monopoly in Railroad transportation State Electricity board have monopoly over generation and distribution of electricity in many of the states. Hindustan Aeronautics Limited has monopoly over production of aircraft. There is Government monopoly over production of nuclear power. Operation of bus transportation within many cities. Land line telephone service in most of the country is provided only by the government run BSNL.

Monopolistic Competition

Some restaurants enjoy monopolistic competition because of their popularity and reputation. Demand for some specific models of automobiles outstrips the production capacity. This creates situation of monopolistic competition. Similar monopolistic situation develops for some given periods for different capital goods product from time to time. Some newspaper in some places enjoy almost monopolistic position in spite of existence of other competitors. Manufacture of some high precision products, such as multi-cylinder diesel engine fuel injection pumps, enjoy monopolistic competition because their competitors are not able to match their quality

Oligopoly

Airlines industry Petroleum refining Power generation and supply in most of the parts of the country Automobile industry Long distance road transportation by bus. Many of there routes have buses operated by limited numbers of operators. Mobile telephony. Internet service providers

Firm's Equilibrium Price and Output: In the short-run, the number of firms in the 'product group' remains the same. The size of the plant of each firm remains unaltered. The firm whether operating under perfect competition, or monopoly wants to maximize profits. In order to achieve this objective, it goes on producing a commodity so long as the marginal revenue is

greater than marginal cost. When MR = MC, it is then in equilibrium and produces the best level of output. If a firm produces less than or more than the MR = MC output, it will then not be making maximum of profits. In the short-run, a monopolistically competitive firm may be realizing abnormal profits or suffering losses. If it is earning profits, no new firms can enter the industry in the short-run. In case, it is suffering, losses but covering full variable cost, the firm will continue operating so that the losses are minimized. If the full variable cost is not met, the firm will close down in the short-run. The short-run equilibrium with profits and short run equilibrium with losses of a monopolistically competitive firm are explained with the help of two separate diagrams as under. Diagram:

In the figure (17.1), the downward sloping demand curve (AR curve) is quite elastic. The MR curve lies below-the average curve except at point N. The SMC curve which includes advertising and sales promotional costs is drawn in the usual fashion. The SMC curve cuts the MR curve from below at point Z. The firm produces and sells an output OK, as at this level of output MR = MC. The firm sells output OK at OE/KM per unit price. The total revenue of the firm is equal to the area OEMK, whereas the total cost of producing output OK is OFLK. The total

profits of the firm are equal to the shaded rectangle FEML. The firm earns abnormal profits in the short run. Short Run Losses: If the demand and cost situations are not favorable in the market, a monopolistically competitive firm may incur losses in the short-run. The short-run equilibrium of the firm with losses is explained with the help of a diagram. Diagram:

In the Figure (17.2), marginal cost (SMC) equates marginal revenue MR curve from below at point Z. The firm produces output OK and sells at OF/KT per unitprice. The total receipt of the firm is OFTK. The total cost of producing output OK is equal to OEMK. The firm suffers a net loss equal to the area FEMT on the sale of OK output.

Price and Output Determination Under Oligopoly: Definition of Oligopoly: Oligopoly falls between two extreme market structures, perfect competition and monopoly. Oligopoly occurs when a few firms dominate the market for a good or service. This implies that when there are a small number of competing firms, their marketing decisions exhibit strong mutual interdependence. By mutual interdependence we mean that a firm's action say of setting the price has a noticeable effect on its rival firms and they are likely to react in the some way. Each firm considers the possible reaction of rivals to its price and product development decisions. Stigler Hads defined oligopoly: "As that market situation in which a firm bases its market policy in part on the expected behavior of a few close rival firms". In the words of Jackson: "Oligopoly is an industry structure characterized by a few firms producing all or most of the output of some good that may or may not be differentiated". The term 'a few firms' covers two to ten firms dominating the entire market for a good. If there are only two firms in the market, the oligopoly is called Duopoly. The analysis of duopoly raises all those problems which are confronted while explaining oligopoly with more than two rival firms. Many industries including cement, steel, automobiles, mobile phones, cigrates, beverages etc.; are oligopolistic. Oligopolies may be homogeneous or differentiated. If firms in an oligopolistic industry produce standardized products like petroleum product, aluminum, rubber products, the industry is said to be producing under oligopolistic conditions. On the other hand, if the firms are producing goods, which are close substitutes for each other, then differentiate oligopoly is said to prevail. Mutual interdependence is greater when products are identical and it is lesser when goods are differentiated. Explanation of Price and Output Determination Under Oligopoly:

There is not a single theory which satisfactorily explains the pricing and output decisions under duopoly. The reasons are: (i) The number of firms, dominating the market vary. Sometimes there are only two or three firms which dominate the entire market (Tight oligopoly). At another time there may be 7 to 10 firms which capture 80% of the market (loose oligopoly). (ii) The goods produced under oligopoly may or may not be standardized. (iii) The firms under oligopoly sometime cooperate with each other in the fixing of price and output of goods. At another time, they prefer to act independently. (iv) There are situations also where barriers to entry are very strong in oligopoly and at another time, they are quite loose. (v) A firm under oligopoly cannot predict with certainly the reaction of the rival firms, if it increases or decreases the prices and output of its goods. Keeping in view the wide range of diversity of market situations, a number of models have been developed explaining the behavior of the oligopolistic firms. Causes of Oligopoly: The main reasons which give rise to oligopoly are as follows: (i) Economies of scale: If the productive capacity of a few firms is large and are able to capture a greater percentage of the total available demand for the product in the market, there will then be a small number of firms in an Industry. The firms in the industry with heavy investment, using improved technology and reaping economies of scale in production, sales, promotion, etc., will compete and stay in the market. The firms using outdated machinery and old techniques of production will not be able to compete with the low unit costs producing firms and eventually wipe out from the industry. Oligopoly is, thus, promoted due to the economies of scale. (ii) Barriers to entry: In many oligopolies, the new firms cannot enter the industry as the big firms have ownership of patents or control over the essential raw material used in the production of an output. The heavy expenditure on advertising by the oligopolistic industries may also be a financial barrier for the new firms to enter the industry.

(iii) Merger: If the few firms in the industry smell the danger of entry of new firms, they then immediately merge and formulate a joint policy in the pricing and production of the products. The joint action of a few big firms discourage the entry of new firms into the industry. (iv) Mutual interdependence: As the number of firms is small in an oligopolistic industry, therefore, they keep a strict watch of the price charged by rival firms in the industry. The firm generally avoid price war and try to create conditions of mutual interdependence. Characteristics of Oligopoly: The main characteristics of oligopoly are as follows: (i) Small number of firms: Oligopoly is a market structure characterized by a few firms. These handful of firms dominate the industry to set prices. {ii} Interdependence: All firms in an industry are mostly interdependent. Any action on the part of one firm with respect to output, quality product differentiation can cause a reaction on the part of other firms. (iii) Realization of profit: Oligopolists firms are often thought to realize economic profits. Whenever there are profits, there is incentive for entry of new firms. The existing firms then try to obstruct entry of new firms into the industry. (iv) Strategic game: In an oligopolistic market structure, the entrepreneurs of the firms are like generals in a war. They attempt to predict the reactions of rival firms. It is a strategy game which they play.