Monopolistic Competition<br>
What is monopolistic competition?
In a monopolistic competition market, many sellers and buyers participate. However, each seller offers a product that is slightly different from the others.
Therefore, to help you understand how this type of competition works, we will explain it in detail in our glossary.
What is monopolistic competition?
Monopolistic competition is a market structure that blends elements of perfect competition and monopoly. It’s widely studied in economics and key to understanding various aspects of marketing and business management.
The products are similar substitutes, but not identical.
Differentiation can be real or perceived, and it comes from factors like quality, design, location, or even brand image.
Differences among main types of competition
| Type of market structure | Number of suppliers and degree of product differentiation | Level of control over pricing | Example |
| Monopoly | Only one supplier, with no alternative products available | Total | Tap water service provided by a monopoly (unregulated) |
| Oligopoly | A few suppliers offering products that may be either homogeneous or differentiated | Partial | Automotive industry (with differentiated products) or chemical industry (with undifferentiated products) |
| Monopolistic competition | Many suppliers offering distinct products | Partial | Fast food sector |
| Monopsony | A single buyer | Total | Public works |
| Oligopsony | Few buyers | Partial | Large distribution chains |
Key features of monopolistic competition
Like in perfect competition, new companies can easily enter and exit a monopolistic competition market.
Each company has some pricing power, but it’s limited by the availability of close substitutes.
Here are some of its core characteristics:
Large Number of Competitors
Many companies compete in the market, each holding a small share. No company has significant control over the market price.
Product Differentiation
They sell products that are similar, but not identical. Each company differentiates its product through features like quality, branding, design, location, and customer service.
This differentiation gives each company a certain level of monopoly power over its own product.
Freedom of Entry and Exit
There are no significant barriers for new companies to enter or exit the market.
This means that if a company makes a profit in the short term, new companies may enter the market and compete, reducing those profits in the long term.
Price Setting Power
Due to product differentiation, each company has some power to set the prices of its products.
However, this power is limited by the competition of similar products offered by other companies.
Advertising and Marketing
Companies invest considerably in advertising and marketing to highlight the unique features of their products and create brand preference among consumers.
This is fundamental in monopolistic competition due to the need to differentiate products.
Downward Sloping Demand Curve
The demand curve of a company in monopolistic competition is downward sloping, which means it can sell more units by reducing the price. However, due to competition, the curve is more elastic than in a pure monopoly.
There Is No Single Price
Unlike perfect competition, in monopolistic competition there is no single market price.
Each company sets its own price based on the perceived value of its product by consumers and the elasticity of demand.
Long-Term Equilibrium
Companies in monopolistic competition tend to earn zero economic profit in the long run.
This happens because new companies enter the market, increasing competition and driving down profit margins.
Productive and Allocative Inefficiency
Brands don’t operate at productive efficiency, meaning they don’t produce at the lowest point on their average cost curve.
There is also allocative inefficiency, as the price exceeds the marginal cost, meaning consumer welfare is not being fully maximized.
Advantages of Monopolistic Competition
Market Adaptability
In a monopolistic competition market, companies can quickly respond to changes in consumer preferences.
Since each company focuses on its specific niche, it can quickly adjust its offering to stay competitive.
Personalized Experiences
Product differentiation allows companies to offer more personalized experiences, such as specialized customer service or unique product features that cater to the specific needs of consumer subgroups.
Encourages Entrepreneurship
Low entry barriers and the potential to capture market share through differentiation attract new entrepreneurs.
This fosters a dynamic and competitive business environment where new ideas have more opportunities to thrive.
Incremental Improvements
Brands tend to make continuous incremental improvements to their products to maintain customer loyalty.
This can lead to ongoing improvements in product quality and functionality, even if they aren’t as disruptive as radical innovations.
Competition Based on Perception
Companies can compete not just on price but also on perception, creating a sense of value that justifies higher prices.
This can be especially beneficial in markets where consumers prioritize quality or exclusivity over price.
Disadvantages of Monopolistic Competition
Limited Economies of Scale
Because companies focus on specific niches, they may not achieve substantial economies of scale, leading to higher production costs compared to a more consolidated market.
Limitation of Consumer Power
Although there is a wide range of options, monopolistic competition can limit consumers’ bargaining power, as product differentiation and strong branding can make them feel “locked in” to a particular brand.
Market Saturation Effect
This can lead to an oversupply of very similar products, potentially confusing consumers and diluting demand.
Unfair Competition
In an effort to stand out, some companies may resort to unfair competition tactics like misleading advertising or product imitation, which can harm consumers and damage the market’s reputation.
Difficulty Establishing Market Leadership
This can limit opportunities for major investments in large-scale innovation or international expansion.
Uncertainty for Companies
High competition and the constant entry of new players into the market create uncertainty for existing companies.
This can make long-term planning challenging and foster an environment where companies prioritize short-term survival over sustainable growth.
Example of Monopolistic Competition
A clear example of monopolistic competition can be seen in the coffee shop market. In this market, various brands compete by offering similar products, such as coffee, tea, and pastries, but each strives to differentiate through unique features.
For example, Starbucks stands out for its cozy atmosphere and drink customization, while a local coffee shop might focus on the quality of its artisanal coffee and a more intimate atmosphere.
Although all these coffee shops sell essentially similar products, each sets its prices based on the perceived value it manages to create among its customers.
Competition is intense, with a mix of large international chains like Starbucks and Costa Coffee and small independent cafés competing to attract a specific audience.
In this environment, product differentiation, customer experience, and marketing strategies play a crucial role in attracting and retaining consumers, making the coffee shop market a prime example of monopolistic competition.
Conclusion
In conclusion, monopolistic competition is a common and realistic market structure that presents unique challenges and opportunities for marketers.
Understanding this structure helps companies develop more effective strategies to compete and stand out in saturated markets.