Monopolistic competition is a type of market structure where there are many sellers, and the product or service they offer is slightly different. The products are differentiated, but not to an extent where each producer can be considered a monopolist. Each seller has an equal share in the market, but none have too much power over the pricing. Today’s article will go over what monopolistic competition means and some other essential aspects.
What is Monopolistic Competition?
Monopolistic Competition is a market structure where many firms are producing identical or differentiated products. This type of Competition occurs in industries with low barriers to entry and exit, meaning that anybody can enter the industry if they wish. In this case, each firm competes against similar companies by differentiating their product from others on factors such as branding or pricing strategies. The main characteristics are:
- Many producers/sellers.
- Small shares held by each producer/seller.
- The homogeneous product sold (i.e., little or no differentiation).
In short, monopolistic competition is a market structure with many small firms that compete based on price and non-price factors. The distinguishing characteristic of this type of market is that some degree of control exists over fees charged for goods sold in such markets. While not as prevalent as perfect Competition or monopoly, industries still resemble those found under these two conditions; examples include restaurants and retail stores (e.g., grocery chains). Additionally, sectors like education and healthcare contain elements of both pure Competition and imperfectly competitive structures. Public universities may adopt monopolistic competition because they set tuition rates but do not wholly dominate their local markets. Hospitals may fall under a monopolistic competition because they compete on factors other than price to attract patients.
Types of Monopolistic Competition
a) Oligopoly:
Oligopoly is a type of market structure dominated by a small number of firms with more or less equal power. Many smaller firms sell products with similar characteristics, yet the entire industry is still considered oligopolistic. Oligopolistic firms use non-price Competition to compete against each other, leaving little or no room for new market entrants. Examples include the soft drink industry (Coca-Cola and Pepsi), automakers (GM, Ford, Honda), or telecommunications companies (like Verizon Wireless, Sprint Nextel Corp., AT&T Inc).
b) Monopoly:
A monopoly is an imperfect market characterized by a single seller/supplier with barriers to entry that prevent others from entering the marketplace as competitors. A firm can become monopolistic either through natural means such as being the first mover in its respective industry (e.g., Microsoft’s dominance in operating systems) or via artificial barriers including patents and copyrights, high start-up costs; economies of scale; or government subsidies.
c) Natural Monopolies and Public Utilities:
Natural monopolies are created when an industry requires enormous initial investments for production facilities, creating high barriers to entry that allow the first firms in a market to operate with little or no Competition. The most common example of this is utility companies which generally have substantial fixed costs and require extensive infrastructure development before they can even begin producing/supplying energy.
d) Duopoly:
This is a market dominated by two firms. In a duopoly, both firms have equal power to influence the price of goods/services being sold in that industry. While there is room for new competitors to enter the marketplace, it can be challenging for them to compete with large established companies because they lack the financial resources required for development purposes. This type of structure is common in many developed nations around the globe, including Canada & USA (e.g., Microsoft-Google), France (Pepsi-Coke), or Japan (Toyota-Nissan).
e) Bertrand Oligopoly:
The Bertrand oligopoly is a market structure where firms compete based on price. It implies that each firm will set its product prices at or just below the industry’s average cost to attract customers and maximize profits. The Bertrand model suggests that there will be an increase in price and a decrease in output when new firms enter into an industry (from P-MC=MR). However, this doesn’t consider what competitors would do because it assumes they act independently from each other. The latter isn’t true for most industries where companies communicate regularly about strategies/prices etc.
Characteristics of Monopolistic Competition
a) Many Firms Operate in the Same Industry
Each firm is small and has little or no control over price determination because they have to regularly react/respond to changes made by competitors. Firms compete with each other based on advertising, product design, new technologies, etc.
It implies that monopolistic competitive markets usually aren’t homogenous (e.g., we may consider some cars a luxury while others are not). The latter allows them to be differentiated from one another, and it also creates more opportunities for companies within that specific market sector. There will always be “niche” segments looking for products/services tailored towards their unique needs & preferences (e.g., high-end fashion vs. the mall).
b) Many Producers and Consumers
This market structure has both producers (firms) and consumers. The number of firms in this type of industry is usually significant. Meanwhile, each firm does not have much control over price or output. They are relatively small compared to other oligopolistic industries like natural monopolies or public utilities, where only one supplier/seller operates within the marketplace. However, on the consumer side, we can argue that individuals living in a region with many local competitive markets will face higher prices than those who live near a monopoly. It’s because monopolistic competitors produce more variety which increases demand for their products while also increasing costs for individual buyers due to so many suppliers being present.
c) Product Differentiation
Another defining characteristic of a monopolistic competitive market is product differentiation. This differentiation occurs when companies in an industry develop unique products that they can differentiate from competitors. These differences may be either physical or non-physical such as via advertising and branding. A good example is McDonald’s, which distinguishes itself from Burger King.
The existence of barriers to entry, high levels of competition among producers, and highly differentiated goods result in meager profit rates for firms operating within this structure. It implies that this type of market isn’t suitable for all businesses, especially smaller ones who lack the resources required to compete with more giant corporations. However, there are still some benefits, including potential short-term gains due to many suppliers/buyers, a chance to expand through mergers & acquisitions, etc.
d) Low Barriers to Entry and Tough Competition
Due to enormous competition between suppliers, monopolistic competitive markets tend to have a more significant number of smaller firms than observed in other market types. The latter includes oligopolies and perfect/pure competitions, and it results from the fact that barriers to entry are relatively low for this type of market. New entrants can enter an industry by providing replacement products or different varieties not currently offered (e.g., companies like Apple & Samsung that produce smartphones with unique features). On top of this, it’s also important to note that while there is room for new competitors within these industries, they face tough competition. Established companies will be well aware of their power over buyers due to their existing product differentiation strategies.
e) Sellers and Buyers Interact
Lastly, it’s important to note that monopolistic competitive firms will actively contact their suppliers and customers. It means they are aware of the actions undertaken by other companies and those who may wish to enter into an industry, mainly if there is a lack of barriers that could allow them to do this easily (e.g., government intervention). On the part of consumers, competition between sellers leads to lower prices than would be possible under perfect or pure competition. Producers must take market demand curves into account when setting the price and the effort required for individual buyers due to high levels of product differentiation, etc. It increases output compared with monopoly because more companies offering similar products increase incentives for consumers to purchase from one of them.
Examples of Monopolistic Competition
- Apple’s smartphone market share is highly differentiated from those of other companies, which allows them to charge higher prices for their phones because consumers are willing to pay a premium rather than purchase a similar device made by another company. It has resulted in many suppliers entering the industry over time due to lower barriers. Still, only one brand was able to achieve enough differentiation through product development and advertising campaigns. This development means they’re now considered as having monopolistic control within this structure.
In terms of mergers & acquisitions, it would be possible for an individual firm operating under monopolistic Competition to purchase smaller competitors. These monopolistic firms have already achieved high levels of product differentiation via branding/advertising strategies etc. They’re armed with these same tactics when purchasing smaller competitors, particularly if they’re willing to lower prices (e.g., buy-out of Whole Foods by Amazon).
The above are just two examples of how monopolistic Competition holds potential for both consumers and companies. However, it’s important to remember there are still downsides that can lead some businesses to be less successful than others due to a large amount of Competition involved in all market structures, whether within or between firms instead.
