Monopolistic Competition
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Introduction
 Introduced by Joan Robinson (The Economics of Imperfect Competition, 1933)
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and Edward H. Chamberlin (TheTheory of Monopolistic Competition, 1933)
It is a market situation in which a relatively large number of producers
offer similar but not identical products.
A combination of perfect competition and monopoly.
Imperfect competition because a large number of sellers sell heterogeneous or
differentiated products and buyers have preferences for specific sellers.
Monopolistic, because each of these sellers makes the product unique by
some differentiation and has control over the small section of market, just
like a monopolist.
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Features of Monopolistic Competition
Chamberlin:
“Monopolistic competition is a challenge to the traditional viewpoint of economics that competition
and monopoly are alternatives…By contrast it is held that most economic situations are
composites of both competition and monopoly.”
Features:
 Large number of buyers and sellers:..
 Heterogeneous products.
 A differentiated product enjoys some degree of uniqueness in the mindset of customers, be it real, or
imaginary.
 Selling costs exist
 Independent decision making.
 Imperfect knowledge.
 Unrestricted entry and exit.
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Demand and Marginal Revenue
Curves of a Firm
Price,
Reven
ue
A
R
O
M
R
Quant
ity
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•If the firm increases the price of its
product slightly, it will lose some, but
not all of its customers;
•if it lowers the price slightly, it will
gain some, but not all of the
customers of its rivals.
•Thus in monopolistic competition:
demand is highly elastic and slope of
demand curve is flatter
•Demand curve for a firm has a
negative slope as all firms in the
industry sell close substitutes of each
other.
Price and Output Decisions in Short
Run
 Joan Robinson: Each firm has a monopoly over its product.
 When product is differentiated, firm has some monopoly power.
 Firms have limited discretion over price, due to the existence of
consumer loyalty for specific brands.
 Negative slope of the demand curve that is instrumental for chances of
monopoly profits in the short run.
 The reason for supernormal profit in short run, is supplying a product
which is differentiated, or at least perceived to be different by the
consumer.
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Price & Output Decisions in Short Run
Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR when MC is rising.
Profit maximising output OQE and Price OPE
Price,
Revenu
e, Cost
PE
B
A
O
E
Q
E
M
C
A
C
AR
M
R
Quanti
ty
Total revenue = OPEBQE
Total cost =OAEQE
Supernormal profit =AEBPE
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since
price OPE > QEB (i.e. AC)
A
P
Price,
Revenue
E
, Cost
O
E
B
M
C
A
C
AR
M
R
QE
Quanti
ty
Total revenue = OPEBQE
Total cost =OAEQE
Loss =AEBPE
since price OPE < QEB (i.e. AC)
Price and Output Decisions in Long Run
Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR when MC is rising.
Profit maximising output OQE and Price OPE
Price,
Revenu
e,
Cost P
E
LM
C
E
O
LA
C
A
R
Q
E
M
R
Quanti
ty
Total revenue = Total cost
=OAEQE
Normal profit = No loss no gain
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price OPE = QEB (i.e. AC)
•Just like perfect competition, in
monopolistic competition too all the
firms would earn normal profits in
the long run.
•In the long run supernormal profit
would attract new firms to the
industry till all the firms earn only
normal profits.
•Losses, will force firms to exit the
industry till remaining firms in the
market earn only normal profits.
•If all the firms only normal profit
there will be no tendency to enter
or exit the market.
Comparison with Monopoly and
Perfect Competition
Price,
Revenu
e,
Cost PM
PM
PC
C
LAC
EM
EM
C
EC
DC
DM
O
QM QM
C
QC
DMC
All firms are in
equilibrium and
earning normal
profit.
Quanti
ty
Perfect competition: horizontal demand curve (DC); output QC; price PC
Monopolistic competition: downward sloping demand curve (DMC);
output QMC (< QC), at price PMC (> PC).
Monopoly: downward sloping less elastic curve D M; output Q M (< QC and
QMC), at price PM (> PC and PMC).
Excess capacity due to market imperfections= QC> Q MC >QM
Monopoly
and monopolistically competitive firm operate at less than
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optimum output, charge a higher price.
Summary
 Most firms compete with each other and have some (if not full) degree of market
power. Thus they lie somewhere between the two extremes of monopoly and perfect
competition.
 Joan Robinson of Cambridge and Chamberlin of Harvard independently came up
with a new concept of market, which Robinson referred to as “imperfect competition”
and Chamberlin termed as “monopolistic competition”.
 A monopolistically competitive has features like large number of buyers and sellers,
heterogeneous product, selling costs, independent decision making, imperfect
knowledge, unrestricted entry and exit.
 It is difficult to define an industry in case of monopolistic competition as firms sell
differentiated products. Alternatively, we identify groups of differentiated products in
this type of market, by clubbing close substitutes from the same industry and regard
them as “product groups”.
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Summary
 Firms under monopolistic competition have a normal demand curve with a
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negative slope because of substitution effect of heterogeneous products, which
are close substitutes of each other.
They may generate supernormal profits or normal profits, or may even incur
losses in the short run.
In the long run all firms earn normal profits due to the feature of unrestricted
entry and exit.
It is profitable for to attract customers through advertising rather than by
lowering the price.
A firm in perfect competition is able to efficiently allocate its resources by
maximizing producer and consumer surplus, though a monopolist and a
monopolistically competitive firm operate at less than optimum output, and
charge a higher price.
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