What is Monopolistic Competition
Monopolistic Competition is defined as an environment wherein the market participants sell differentiated products, yet serve the same end market.
In economics, monopolistic competition is considered to be a hybrid between a monopoly and perfect competition, as the market structure blends the characteristics of each.
Table of Contents
How Does Monopolistic Competition Work in Economics?
In the field of economics, monopolistic competition refers to a market structure that entails many companies (i.e. sellers) offering a differentiated product but with a virtually identical utility to the end-user.
While the products might be largely the same in their intended purpose, i.e. the benefit received by the customer, there are still attributes that cause the products to be somewhat differentiated.
Therefore, in an environment of monopolistic competition, market participants compete on quality, price, and marketing.
The most common characteristics of monopolistic competition are as follows:
- High Number of Market Participants: In monopolistic competition, there are many independent companies involved that actively compete within the market.
- Differentiated Products to Serve an Identical End-Market: Each company produces and sells a differentiated product, but the function of the product is comparable, i.e. the product has many close substitutes, although there is no perfect substitute.
- Low Barriers to Entry: Another unique feature of monopolistic competition is the freedom of entry and exit present in the market. Entrance and competing in the market are relatively easy for new companies (and it is also easy to exit), but of course, there is the opportunity cost of time to consider.
What are the Characteristics of Monopolistic Competition?
Companies in monopolistic competition often operate with excess capacity, meaning there is a mismatch in supply and demand.
The reason for the inefficiency is that these companies must strategize methods to differentiate their offerings from the rest of the market.
For example, a company can overspend on marketing and advertising, or focus too much on the non-core components of a product such as the packaging material rather than focusing on product capabilities.
Differentiated products can be identified by consumers by their specific marketing tactics, branding, and quality. The products sold can be different on the basis of the following aspects:
- Product Quality
- Marketing Tactics
- Branding, i.e. Public Perception
- Stylistic Add-On Features
- End-User Convenience
- Geographical Location
Notably, a market with monopolistic competition comprises a high number of active competitors in the space that each sell product(s) to serve the same or an adjacent end-market. In effect, consumers have more options in terms of which product to purchase.
The market participants compete on many of the traits listed above and try to improve upon their offerings in order to grab more market share. The specific factors that differentiate the company’s offerings tend to dictate its marketing and sales strategy.
The drawback to the ease of entry into such a market is that the news of selling products at high-profit margins spreads quickly and eventually causes an increasing number of new companies to enter the market.
Low barriers to entry indicate that new entrants encounter minimal challenges when entering the market, or at least not enough in comparison to a monopoly. The absence of high barriers to entry means that no company can make outsized economic profits over the long run.
