Monopolistic Competition

• Monopolistic competition is a market

structure in which a relatively large
number of sellers offer similar but not
identical products. The features of
monopolistic competition are:
• Large number of buyers and sellers
• Free entry and free exit
• Heterogeneous Product (product
differentiation)
• Selling cost (expenditures to promote the
product i.e, advertising, packaging,
incentives to buyers commission to
distributers etc.).
 Both the selling cost and product costs are
considered under Monopolistic competition

• Independent decision about price and output of

rival firms

• Complete dissemination of market knowledge in

respect of cost, quality and price etc.

• In the service sector of India, Institutions of primary and

secondary education and organisation of health care are
good examples of monopolistic competition.

• E.H Chamberlin of Harvard University: The theory of monopolistic

competition
• Joan Robinson of Cambridge University: The economics of imperfect
competition.
Industry under monopolistic
competition
• It is difficult to define industry under
monopolistic competition on account of
product differentiation. One can identify
the product group by clubbing the
products with close substitute of the
same industry under monopolistic
competition. Ex: different types of tooth
pastes, soaps etc. these products can
not be classified as an industry but it
would be convenient to classify them as
product groups. These products are
good substitutes but not perfect
substitutes.
Product differentiation under monopolistic
competition:
• Product differentiation is based on patent,
trademarks and brand names etc. which are
created through advertising to attract the
buyers to buy the product
• Product differentiation may be based on the
conditions surrounding the sale of the product.
Chamberlin pointed out that the surroundings
include “the convenience of the sellers location,
general character of his establishment, his way
of doing the business, his reputation of fair
dealing, courtesy, efficiency and all others which
attract his customers either to himself or to
those employed by him”. These are intangible
factors which are taken into consideration while
making the purchases.
 Demand and Marginal revenue
curve
• The demand curve is negatively sloped
like a normal demand curve because all
the firms sell heterogeneous products
which are close substitutes of each other.
The substitution effect results in the
negative slope of the demand curves. The
demand is highly elastic under
monopolistic competition while it is highly
inelastic under monopoly. The slope of the
demand curve is flatter under
monopolistic competition as compared to
monopoly. The demand curve is the AR
curve of the firm and determines the
slope of the MR curve.
 AR and MR curve under
monopolistic competition
P
AR curve is highly elastic
r and MR curve is
i determined by the AR
c
e
curve
,
R
e
v Quantity
under MC
The MC is closely similar to PC but the
price and output determination is similar
to monopoly.
The demand curve is downward sloping
and MR curve lies below the AR curve.
The necessary condition for profit
maximisation is MC=MR.
The firms earn economic profit in the
short run. The rate of profit is not the
same for all the firms because of product
differentiation which makes different
elasticity of demand for different
products. In this case some firms may
 Short run price-output
Y determination
Profit MC
AC
D
A
B
C

AR
M
R
O Q X
Output
 At E, AR=AC, the
Long run equilibrium firm earns only
LAC normal profit, no
LMC tendency of new
entry is possible.
All the firms are
P1 identical in
P respect of
demand and cost
Re curves. The long
v,c P2 run equilibrium is
ost established at
E less than the
AR optimal output.
The firm would have
produced OQ1
output which is
its full capacity
without any loss.
MR
Hence QQ1 (OQ1-
OQ)is the excess
O capacity of the
Q Q1
firm. It is possible
Quantity under long run.
• What are the reasons for excess capacity?
(i)The AR curve is tangent to the AC curve at its
falling portion. It is not possible under Perfect
competition as the demand is perfectly elastic. Hence
greater the elasticity of AR curve or demand of the
monopolistically competitive firm, the less is the
excess capacity and vice versa. AR curve slopes
downward because of product differentiation under
Monopolistic competition. Each product has certain
degree of monopoly.
(ii) Entry of large number of firms in the long run is
another reason for excess capacity.
 D is the original
demand curve and
the equilibrium
LAC output is OQ which
LMC is the ideal output
in the long run
where all the
N resources are
P M efficiently utilised.
New firms will be
attracted by the
economic profit
D and the demand
curve will go on
E shifting to the left
until the AR(D)
becomes tangent
to the LAC. The
D1=AR consumer pays a
MR higher price here.

O
Q1 Q Quantity
 Selling cost and group equilibrium
• Selling cost under MC includes the expenses of advertisement
and such other expanses which influences market demand to
a great extent. Under advt. the demand curve of one firm
shifts at the expense of other firms offering similar products.
This is possible due to product differentiation. Such expenses
are the selling costs of the firms which is known as non price
competitive equilibrium under monopolistic competition.

• Initially the sales of firms increase at increasing rates and

then gradually at decreasing rates. So the ASC (average
selling cost) initially declines and start increasing afterwards.
So ASC curve is U shaped like conventional AC curves. This is
one type of non price competition the firms face under MC. In
this situation the total sales are subject to diminishing
returns to increasing selling costs. This lefts almost all the
firms in similar situation and this selling costs lead all the
firms to an almost similar situation of equilibrium which
Chamberlin calls “ Group Equilibrium”.
With no selling cost, the
equilibrium is at S with
OQ quantity and OP2
Group Equilibrium
price firms earn only
normal profit. Suppose
one of the firms
advertised and with
selling cost , the
equilibrium out put
raised to OQ3 and the
firm earns super normal N
profit (P2PMP1) and no S R P
other firms advertised.
when other firms start
advertising and incur M
selling costs, the initial
equilibrium will change
and the output falls to
OQ1 and all firms are in
equilibrium at R. But the
firms will try to reduce T
their production cost by
increasing the sales. The
APC+ ASC will shift till it
is tangent to AR=MR. All
the firms as a group are
at equilibrium at N and
earns normal profit.