Monopolistic competition is a type of imperfect competition such that many producers are competing against each other, but selling products that are differentiated from one another, and hence are not perfect substitutes. Companies in this competition make economic profits in the short run, but in the long run, they make zero economic profit. The latter is also a result of the freedom of entry and exit in the industry. Economic profits that exist in the short run attract new entries, which eventually lead to increased competition, lower prices, and high output.
It is a form of competition that characterizes several industries that are familiar to consumers in their day-to-day lives. Examples include restaurants, hair salons, clothing, and consumer electronics. To illustrate the characteristics of monopolistic competition, we’ll use the example of household cleaning products.
Characteristics of Monopolistic Competition
- The presence of many companies
- Each company produces similar but differentiated products
- Companies are not price takers
- Free entry and exit in the industry
- Companies compete based on product quality, price, and how the product is marketed
- Each firm earns only normal profit in the long run.
Difference between Monopoly and Monopolistic Competition
| Comparison | Monopoly | Monopolistic Competition |
|---|---|---|
| Meaning | It refers to a market structure where a single seller produces/sells products to a large number of buyers. | It is a competitive market setting wherein many sellers to offer differentiated products to a large number of buyers. |
| Number of players | One | Two to Ten or even more. |
| Product differentiation | Extreme | Slight |
| Degree of control over price | Considerable but very regulated. | Some |
| Competition | Does not exist. | Stiff competition exists between firms. |
| Demand curve | Steep | Flat |
| Barriers to entry and exit | Many | No |
| Difference between firm and industry | No | Yes |