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CHAPTER 13 : MONOPOLISTIC COMPETITION
13.1 Market Imperfection
(A) Quantitative and Qualitative Differences:
Traditionally a competitive market is considered an ideal form of
market. As a rule almost all markets are competitive in nature.
Only in exceptional cases certain market imperfections may cause
departure from competition. Such exceptions to competition are in
the form of monopoly, oligopoly or duopoly. However, all these forms
are numerically and quantitatively dissimilar to competition. Traditional
analysis does not take account of qualitative differences. The number
of firms may remain fairly large to make the market appear competitive.
Yet there may be noticeable varieties in the price charged and the
profits earned by individual firms. This can be explained thus:
such modern markets have started emerging in the 1920s. Traditional
competitive analysis could not explain them. The conclusion drawn
was that modern competitive firms deliberately create qualitative
differences in their products and in their selling activities. In
other words, modern firms differentiate their products. Firms producing
biscuits, soaps, chocolates, stereo systems and TV sets are all
examples of product differentiating firms. This new trend among
producers demands a different approach to analyze their behavior.
Two young economists Joan Robinson in England and Prof.
E. H. Chamberlin in the U.S presented their respective theories
on Imperfect Competition and Monopolistic Competition
in the earlier half of the 20th century. We will
presently review monopolistic competition.
(B) Main Features of Monopolistic Competition:
Monopolistic competition is a modern form of the market. A large
variety of goods are sold in such a market. Its main features can
be stated as follows:
i) Large Number: The number of firms operating
under monopolistic competition is sufficiently large. Moreover there
is freedom of entry. There are no quantitative restrictions or differences
in market conditions. However, each firm differs from its rivals
in some qualitative respect.
ii) Close Substitutes: In case of a monopoly
there are no substitutes available. Under monopolistic competition
firms produce very close substitutes. Chocolates of one company
may serve a similar purpose as that of some other firm. The only
difference may be of some variation in the quality of the product.
iii) Group: Firms under monopolistic competition
together form a group. They cannot be called an industry. This is
because their products are somewhat dissimilar and not homogenous
as under competitive industry.
iv) Product Differentiation: Under monopolistic
competition products are differentiated. This is the outstanding
feature of this form of market. Otherwise monopolistic competition
closely resembles perfect competition. The fundamental difference
between the two is that products are no more homogenous. Goods produced
are deliberately differentiated. By differentiation we mean the
goods are made to appear somewhat different and superior
to those produced by other firms. Product differentiation may be
real or apparent. By real differentiation we mean that a difference
is maintained in some physical or chemical composition of a product
or in the taste and appearance of that product. This is easily done
with the help of attractive packaging; or some extra services are
rendered. A product can also be marketed as superior using local
advantage. When products are differentiated more buyers are likely
to be attracted. Thereby the firm gains extra control over demand
and market conditions. The demand curve of a firm will then alter
to the advantage of a firm. It will become more flexible and shift
upwards. A firm’s capacity to alter the demand curve for its own
product is the chief analytical feature of monopolistic competition.
Under no other form of market do producers attempt to influence
the demand which is entirely based on consumer behavior. Gains of
product differentiation have been shown in Figure 49. In the figure
dd is the original demand curve that the firm faces before
product differentiation.
On this demand curve at market price P the firm sells output Q. When the firm differentiates its product successfully its demand curve alters and is now d1d1. On the new demand curve the firm at point R1 can charge a price as high as P1 and sell old output Q. It could also charge the same price P and sell a very large output Q1 at point R3. Or then the firm could choose a somewhat higher price (higher than P1 but lower than P2) P2 at point R2 and sell a somewhat larger quantity Q2.
(v) Selling (Advertising) Cost: Selling
Cost (SC) is another outstanding feature of a monopolistic competitive
market. This in the form of advertisement expenditure. Selling Cost
and Product Differentiation together enable the producer to maintain
some control over market conditions and influence the shape of the
demand curve. Both features are interdependent. Whenever a product
is differentiated it is necessary to inform buyers; and advertisement
is the only medium through which buyers can be told about superiority
of that product. Selling Cost by itself is apparent product differentiation.
When a product does not contain any genuine qualitative difference,
buyers can be made to treat a product differently through advertisements.
So whenever products are differentiated and advertised, the market
becomes a monopolistic competition. These are the hallmarks of this
form of market. The presence of selling cost increases the firm’s
cost of production. In order to recover it, firms have to charge
a higher price. The net effect of a monopolistic competitive market
is pricing goods at a higher rate. Consumers have to bear this extra
expenditure.
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