The monopolistic competition model describes a common market structure in which companies have many competitors, but each of them sells a slightly different product.
Many small businesses operate under conditions of this type of competition between shops, restaurants, hotels and self-made products (e.g. craft beers, clothing, food, etc.)
To get a slightly clearer idea, let’s take the example of Pepe’s restaurant: He sells Argentinian steaks, which is surely not the same as in other places, since each one offers something different and has an element of uniqueness. But they all compete for essentially the same customers.
Characteristics of monopolistic competition
- Differentiated products
- Low barriers for entry and exit
- A large number of independent companies
- Short-term normal gains
- Normal long-term benefits
- New companies enter the market easily
- The market is dynamic (as new companies enter)
Balance under monopolistic competition
In the short term it is possible to make profits, but in the long term new companies are attracted to a specific industry because of low entry barriers, good knowledge and the opportunity to differentiate themselves.
Competition in the short term
In the following graph you can see the profit maximization, MC = MR, and the production is Q and the price P. Since the price (AR) is above ATC in Q, it is possible to obtain profit (PABC area).
As new companies enter the market, the demand for a company’s products becomes more elastic and the demand curve shifts to the left, driving the price down. Eventually, all profits are lost.
Attracting new customers shifts the demand curve to the left, so that companies begin to reach a long-term equilibrium.
It is clear that the company benefits most when it is in the short term and will seek to sustain itself in the short term through innovation and greater product differentiation.
The advantages of monopolistic competition
These can be:
- No significant barriers to entry; therefore markets are relatively contestable.
- Differentiation creates diversity, choice and utility. For example, a typical main street in any city will have a number of different restaurants to choose from.
- The market is more efficient than the monopoly, but less efficient than perfect competition: This means that it is less efficient in terms of allocation and production.
However, they can be dynamically efficient, innovative in terms of new production processes or products.
For example, retailers often have to constantly develop new ways to attract and retain local customs.
The disadvantages of monopolistic competition
There are several possible disadvantages associated with this, including
- Some differentiation does not create utility, but rather generates unnecessary waste, such as excess packaging. Advertising can also be considered wasteful, although most of it is informative rather than persuasive.
- There is an inefficiency in allocation both in the long and short term. This is because the price is above cost in both cases. In the long term the company is less inefficient in allocation, but remains inefficient.
Can a company become inefficient in this type of competition?
The company is inefficient in terms of allocation and production, both in the long and short term.
There is a tendency towards overcapacity because companies can never fully exploit their fixed factors because mass production is difficult.
This means that they are productively inefficient in both the long and short term. However, this can be overcome by the advantages of diversity and the choice of a product or service.
As an economic model, monopolistic competition is more realistic than perfect competition, many familiar and common markets have many of the characteristics of this model.
Did you know that a CRM can help you be relevant in the monopolistic competition?
Yes, because it shows you the evolution of each action you implement, thus measuring your results and making decisions in favour of your company.
In addition, it helps you to have all your commercial, administrative and marketing procedures in one place.
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