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Monopolistic competition is an economic concept referring to a state of competition in which large numbers of firms offer similar, but slightly different, products. Despite sounding like an oxymoron, monopolistic competition is actually a fairly common arrangement in most economies.
In most modern economies there are a large numbers of franchises that sell similar, though not perfectly substitutable, products. Each company owns their own product, often trademarked, not unlike how a monopolist may exclusively supply some good. This is most obvious in the case of chain restaurants or hotels, where different companies may all sell very similar things (hamburgers, hotel rooms) but all with some variation on the specific good or service. Because of this, each firm has some control over price, but unlike a monopolist they have to face competition. Competition is carried out via product differentiation, unique differences between each brand. Each firm may offer, say, hamburgers, but they have to set themselves apart from other restaurants. Differences in price are rarely the major selling point, rather differences in customer service, quality, experience, perks and benefits are used to attract consumers.
In the short run, firms earn profits visualized by the difference in their average revenue (demand) curve and the average cost curve. Multiplying the absolute value of that gap by the units of product sold yields total profits. Over the long run, however, more firms tend to enter the market and try to cash in on opportunity. Long-run average costs (LRAC) eventually equalize to some point on the AR curve and no excess profits are made anymore. Firms also face increasing marginal costs over the long run as well. Although monopolistic competition is generally thought of as a form of imperfect competition, it is not usually associated with all the negatives monopolies and oligopolies are. Additionally, monopolistic competition tends to be the form that most people experience in their daily lives unlike other textbook forms of competition which are more theoretical.
Like perfect competition there are some basic assumptions regarding monopolistic competition including:
- Producers are not price takers, they have some control over what they charge.
- Product differentiation: Each firm has a different take on the product being sold.
- Relatively low barriers to entrance. Few excessive laws or upfront costs that hinder access to market.
- Large numbers of buyers and sellers at any given time.
Some very basic examples of industries where multiple companies offer similar products include.
- Fast Food (McDonald's vs. Burger King)
- Hotels (Holiday Inn vs Super 8)
- Gyms (Planet Fitness vs. LA Fitness)
- Chappelow, Jim. "Monopolistic Competition". Investopedia. Retrieved January 30, 2020.
- "Monopolistic competition". Encyclopedia Britannica. Retrieved January 30, 2020.
- Robinson, J. (1969). The economics of imperfect competition. Springer.
- "Monopolistic competition". stats.oecd.org. Retrieved January 30, 2020.