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What is monopolistic competition?

In monopolistic competition, there are many small firms who all have minimal shares of the market. Firms have many competitors, but each one sells products that are not considered “identical”.  Characteristics of monopolistic competition include:

Product Differentiation – The product of a firm is similar, but not an exact substitute for another firm. This differentiation gives some monopoly power to an individual firm to influence the market price of its product.

Barriers to Entry – There are no barriers to entry. This ensures that there are neither abnormal profits nor any abnormal losses to a firm in the long run.

Number of Sellers – There are large numbers of firms selling closely related, but not homogeneous products. Each firm acts independently and has a limited share of the market. So, an individual firm has limited control over the market price.

Marketing – Products are differentiated, and these differences are made known to the buyers through advertisement and promotion. These costs constitute a substantial part of the total cost under monopolistic competition.

Imperfect Knowledge – There is imperfect knowledge in the market. People don’t know who is selling the good the cheapest or who has the best quality. Sometimes a higher priced product is preferred even though it is of inferior quality.

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    Perfect competition describes a market structure where a large number of small firms compete against each other. In this scenario, a single firm does not have any significant market power. As a result, the industry as a whole produces the socially optimal level of output, because none of the firms can influence market prices.