In monopolistic competition there are many firms selling a differentiated product or service. It is a blend of competition and monopoly.

1. MONOPOLISTIC COMPETITION

2. Monopolistic Competition
 Up to 1920s the classical theory of price mainly discussed about pure competition
and monopoly as the market structures.
 The assumption of homogenous product in the theory of pure competition was not
fit to the real world.
 Common business practices like advertisements, product differentiation etc., are not
explained in the theory of pure competition.
 Firms expanded their output with falling cost as predicted by the theory of pure
competition made dissatisfaction among the economists in the 1920s.
 According to Piero Sraffa, instead of infinitely elastic demand curve, negatively
sloped individual demand curve is more operational and theoretically plausible.
 The same was the argument of E Chamberlin and Joan Robinson

3. Monopolistic Competition defined….
 In monopolistic competition there are many firms selling a
differentiated product or service
 It is a blend of competition and monopoly.
 The competitive elements result from the large number of firms and
the easy entry.
 The monopoly element results from differentiated (i.e., similar but not
identical) products or services
 Product differentiation may be real or imaginary and can be created
through advertising
 The availability of close substitutes severely limits the “monopoly”
power of each firm

4. Characteristics of Monopolistic Competition
 Large number of buyers and sellers
 Product differentiation – close substitutes
 Selling cost
 Freedom of entry and exit
 Firm’s objective is to maximise profits in the long-run and short-run.
 Prices of factors and technology are exogenously given
 Lack of perfect knowledge of the market
 Under monopolistic competition both the factors of production as well as goods and services are not perfectly mobile.
 The firm behaves as if it knows about demand and cost curves with certainty
 The decisions in one period do not affect future period.
 Both demand and cost curves for all products are uniform in the industry.
 So that the equilibrium of firm and the industry can be depicted in the same diagram.

5. Non price competition
 According to Chamberlin, demand is determined not only by price policy of the firm
 Therefore, firms under monopolistic competition would not cut price to enhance
sales.
 Style of the product along with the services associated with it and the selling
activities of the firm are the basis for non-price competition
 Product differentiation – distinguishes the product of one producer from that of the
other producers in the industry.
 Real differentiation – differences in the specification of the products – differences in the factor
inputs, or the location of the firm.
 Fancied differentiation – difference in design, packaging, brand name etc.
 The aim of product differentiation is to make the product unique
 Such non price competition makes the demand curve of the firm a negatively sloped
one
 Product changes, advertising and salesmanship are the main means of product
differentiation

6. Non price competition
Apart from price competition, different ways of non-price competition are also
prevalent.
Types of Non-price competition
 Product differentiation: The producers differentiate their products by altering quality
and design. This way, the producers make the products more attractive to
consumers.
 Publicity: It’s a very common practice of the producers to make their products well-
known and more familiar to their customers by way of publicity. They follow different
sales promotion strategies like advertising, free trial offers, discount coupons,
personal sales promotion through representatives, creation of distribution channels
etc.
 After sale service: To keep their customers, for long time, the producers offer after
sale services to their customers. This makes the products more attractive to their
customers

7. Non price competition
 Brand name: Branding is another important marketing strategy. For a long-lasting
customer base, the firms are intended to provide a better image about their
company and products in the minds of the customers by way of different sales
promotion strategies and loyalty programmes. Thus brands provide clarity and
guidance for choices made by companies. Advertising increases brand recognition
and brand loyalty.
 Customisation: Customers are interested to purchase products modified to their
taste and preferences.
 Location/Convenience: For some services and products , being in the right location
is more important.
 Online Reviews: Now a days, online reviews in major portals related to marketing is
an important strategy on non-price competition.
 Loyalty Cards: Some big business have invested considerably in loyalty cards which
give ‘rewards’ or money back to customers who build up points/spending.

8. Non price competition
 Subsidised Delivery: Sometimes marketers and producers offer subsidised delivery
for their products to make them more attractive.
 Ethical/charity concerns: Some firms may promote an ethical line of marketing. Eg.,
fair trade, announcements on spending a part of their returns for charity services
etc.
 Personal selling/Direct selling: Some producers promote their sales by adopting
direct marketing and door to door selling/delivery.
 Late night shopping, being part of shopping festivals, providing offers on festival
seasons, Taking the lead role in conducting different festivals etc. are some other
non-price competition strategies followed by the firms/producers.

9. Short-run Equilibrium under Monopolistic Competition
Profit Maximising firm
 The monopolistic competitor faces a demand curve which is
negatively sloped (because of product differentiation) but highly
elastic (because of the availability of close substitutes).
 The monopolistic competitor’s profit- maximising or best level of
output is the output at which , provided .
 MR curve lies below the demand curve
 At that output, the firm can make a profit, break even, or minimize
losses in the short run

10. Short-run Equilibrium under Monopolistic Competition
Profit Maximising firm
 Price (𝑃) and Costs (𝐶) are measured on the
vertical axis
 Output 𝑄 measured on the horizontal axis.
 For a firm facing monopolistic competition,
Demand curve 𝐷 is highly elastic.
 The corresponding 𝑀𝑅 curve 𝑀𝑅 lies below
the demand curve
 𝑆𝑀𝐶 is short run marginal cost and 𝑆𝐴𝐶 is
the short run average cost.
 The equilibrium level of output 𝑄 is
determined where 𝑆𝑀𝐶 cuts 𝑀𝑅 from below.
 The point where 𝑆𝑀𝐶 cuts 𝑀𝑅 is 𝐸

11. Short-run Equilibrium under Monopolistic Competition
 is the corresponding output where
cuts
 The corresponding Price level is
 The monopolistic competitor
maximises profits at this level
 The total profits would be
 Thus is the best level of output.

12. Long-run Equilibrium under monopolistic competition
 If there is profits in the short run in
a monopolistically competitive
industry, new firms will enter in the
long run
 This shifts each firm’s demand
curve down until all profits are
squeezed out – the demand curve
shifted from to
 Now each firm has a smaller share
of the market.
 The corresponding marginal
revenue curve is

13. Long-run Equilibrium under monopolistic competition
 The long run equilibrium level of
output is where the cuts
at point
 At this level the also cuts
 is the corresponding level of
output.
 Correspondingly the long run
average cost curve is tangent
to the demand curve
 At this level

14. Ideal output and Excess Capacity
 In monopolistic competition there will be too many firms in the industry, each
producing an output less than optimal – at a cost higher than the minimum.
 The tangency of 𝐴𝐶 and demand occurs necessarily at the falling part of the 𝐿𝐴𝐶 –
at a point where 𝐿𝐴𝐶 has not reached its minimum level.
 Production costs will be higher than in pure competition.
 In monopolistic competition firms incur selling cost which are not present in pure
competition.
 Total costs will be higher
 In monopolistic competition, too many, too small firms, each working with excess
capacity – difference between the ideal output

15. Ideal output and Excess Capacity
 𝑋 is the long run where 𝐿𝑀𝐶
cuts 𝑀𝑅.
 However the minimum costs
comes only when the firm
produces 𝑋 level of output.
 Because of the product
differentiation, the firm faces
another demand curve 𝐷 for the
products, which is less elastic
than the original demand curve.
 The difference between the ideal
output 𝑋 and the actual output
attained in the long run
equilibrium 𝑋 is calculated as
excess output.
D
d
LMC
LAC
P
C
0 X
Excess Capacity
XE XF
MR

16. Ideal output and Excess Capacity
 In a market system of monopolistic competition, firms are working at suboptimal
scales
 Misallocation of resources – market does not employ optimum level of resource
utilisation to reach the minimum average cost
 According to Chamberlin excess capacity and misallocation of resources is valid
only if the demand curve is horizontal.
 If price competition is prevailing, with a downward sloping demand curve, 𝑋 cannot
be considered as socially optimal level of output.
 Consumers wants are for variety of products
 Product differentiation makes the producer to offer the products to satisfy the
consumer’s desire
 In that case consumers would be willing to offer higher price.

17. Ideal output and Excess Capacity
 The higher cost resulting from producing to the left of the minimum
average cost is thus socially acceptable.
 Therefore the difference between the actual output and minimum
cost output is not a measure of excess capacity but rather a
measure of social cost.
 Thus the output is ideal output in a market in which product is
differentiated
 This is the argument made by Chamberlin on the assumptions of
active price competition and free entry.
 Under these circumstances the equilibrium output will be very close
to the minimum cost output.

18. Ideal output and Excess Capacity
 Firms will be competing along their
individual 𝑑𝑑 curves which are very
elastic
 Instead of price competition, if they
enter into non-price competition there
will be excess capacity in each firm and
insufficient productive capacity in the
industry – unexhausted economies of
scale for the firm and industry.
 According to Chamberlin, excess
capacity and higher price are the result
of non-price competition and free entry.
 Here the firm ignores is dd curve (price
adjustment is irrelevant)

19. Ideal output and Excess Capacity
 Long run equilibrium is reached only
after entry has shifted the 𝐷𝐷 curve to a
position of tangency with the 𝐿𝐴𝐶 curve.
 Excess capacity is the difference
between 𝑋 and 𝑋
 𝑋 is ideal level of output
 In the absence of price competition firm
produces the output at level X
 According to Chamberlin, excess
capacity in monopolistic competition is
the result of absence of an active price
competition.