Is it not surprising that there are so many alternatives for flight and bus travels but not for Indian railways? Monopoly versus monopolistic competition is the answer to this question. Monopolistic competition refers to a market structure in which there are many companies, but each offers a slightly different product. Due to low entry and exit barriers, fierce competition is prevalent.

“Competition is always a good thing. It forces us to do our best. A monopoly renders people complacent and satisfied with mediocrity.” — Nancy Pearcy

Monopolistic competition is the antithesis of monopoly. Product differentiation is the only thing that makes monopolistic competition stand out from a perfect competition. As monopolistic competition has this perk of free entry, there are too many firms competing for one product. So, the firms engage in product differentiation despite producing the same sort of goods. A firm can distinguish its products from the products of other firms by offering a different marketing strategy or appearance. Searching for restaurants near you on Google will reveal thousands of listings. They all produce slightly different products and try to distinguish themselves from each other. For example, let us assume that there are more than 30 top rated restaurants around the Christ University BGR Campus. The menus and prices will be pretty identical. On one hand, there are few restaurants out there having no customers and On the other end of the spectrum are restaurants with well-established names and prices far above their cost of production, which are constantly booked.

There are many restaurants in Bangalore. A buyer in this market has hundreds of competing products from which to choose. And because anyone can enter the industry by opening a small food truck or fast food joint, for every highly earning restaurants, there are hundreds of struggling ones. In real or imaginary terms, they succeed by doing something different.

Unlike monopoly and oligopoly, monopolistic competition does not make the size of a firm affect market prices. A prime rib dinner’s market price cannot be affected by a single restaurant even though each restaurant can control its own price.

Instead, firms gain control over price in monopolistic competition by differentiating their products. This is because good substitutes are actually available in a monopolistically competitive industry. Pricing is often a key strategy for companies competing in monopolistic competition. It is often difficult for the average consumer to discern the differences between the various products and determine what a fair price might be since they all serve essentially the same purpose.

What makes a product survive in a competitive market when another product is better? It’s all about the price, of course. Behavioral economists suggest, however, that there may be times when too much variety may be detrimental. Various experiments have suggested that individuals prefer lesser information to make choices. As the number of alternatives increases the difficulty in choosing the best alternative also increases. Of the many restaurants in Bangalore, some are south Indian, some are Chinese and some are north Indian. This form of differentiation across the restaurants is described as HORIZONTAL DIFFERENTIATION by economists. It means “A difference in the product that improves it for some people but makes it worse for others”. Research shows that the complexity of a decision increases as the number of options increases. While people are naturally drawn to having lots of choices, they often find themselves paralyzed and unable to make a decision when faced with a large number of options.

Who sets the price in monopolistic competition?

Prices are not determined by supply and demand forces in monopolistic competition. Pricing is determined by firms since they sell similar, yet distinct products. As a result of the highly elastic nature of demand, any change in pricing can cause demand to shift from competitor to competitor. As monopolistic competition has many firms competing with each other, no firm has the so called “PERFECTLY ELASTIC DEMAND”. Which means, if KFC increases the price of a chicken burger, people would eventually go to McDonald’s for purchasing the same. Due to this, KFC might lose its market share. As the market is highly reactive in case of monopolistic competition, each firm decides its own price. When price increases demand falls and vice versa. That is why, it has a downward sloping demand curve.

In a monopolistic industry, new firms will be attracted to the industry if they earn super-normal profits in the short run. It is true for a fact that the entry of a new firm in a profitable market decreases the price and the profit per firm, as the total demand is now shared by more firms. As a result, all firms earn only normal profits. Consequently, firms in such markets earn only normal profits over time. Hence, Firms will continue to enter until the economic profit becomes zero.

As there are wide range of product options available in this monopolistic competition, Is it possible to generate some profit out of this industry?

In the short run, the mechanics of monopolistic competition are identical to those for the monopolist’s problem, whereas in the long run the equilibrium mirrors perfect competition. Thus, much like a monopolist, a monopolistically competitive firm can increase price and not lose all of its business. In the short run, monopolistic competition is just like a monopoly. In a monopolistically competitive market, marginal revenue is not equal to price since a small price increase does not eliminate all customers. Its demand curve is more elastic than perfect competition because close substitutes (But not the same) for the products are available. In profitable markets, new firms enter the market until profits are eliminated. With more entrants, less demand is left for older firms. Profits would be positive if goods were produced at a quantity above the average total cost curve.

When MR=MC, a firm maximizes profit. Profits are super normal at output Q1 and price P1.

This attracts the rivals- Demand curve shifts left side- Lower profits- Exit of few rivals from the industry- Rightward Shift of demand curve for the remaining firms- increased profits or decreased losses- MR=MC.

In a long run, overtime, Supernormal profits encourage the entry of new firms. Existing firms are thus less likely to be in demand, resulting in normal profits. Whether the market is at equilibrium in the long run depends on whether there are no further exits or entries or on the number of profits made by all firms.

Thus, for all of the aforementioned reasons, it is challenging for rivals to succeed in monopolistic competition. Monopolistic rivalry has certain positive benefits, such as an active business environment, a wide range of goods and services, and improved product quality, which outweigh the drawbacks despite being a place where companies compete to make a lot of money.

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