Monopolistic competition

There are eight characteristics of monopolistic competition (MC): • Companies are price setters. • Free movement of resources from one company to another. • Product differentiation. • Many companies. • Freedom of entry and exit. • Independent decision making. • Some degree of market power. • Buyers and sellers do not have perfect information. Product differentiation MC companies sell products that have real or perceived non-price differences. Examples of these differences could include physical aspects of the product, location from which it sells the product or intangible aspects of the product, among others. However, the differences are not so great as to eliminate other goods as substitutes. In technical terms, the cross price elasticity of demand between goods in such a market is large and positive. MC goods are best described as close but imperfect substitutes. The fact that there are "many companies" means that each company has a small market share. This gives each MC company the freedom to set prices without engaging in strategic decision making regarding the prices of other companies (no mutual dependence) and each company's actions effect the market negligibly. For example, a company could reduce prices and increase sales without fear that its actions will prompt retaliatory responses from competitors. The number of companies that an MC market structure will support at market equilibrium depends on factors such as fixed costs, economies of scale, and the degree of product differentiation. For example, the greater the fixed costs, the fewer companies the market will support. Freedom of entry and exit Like perfect competition, with monopolistic competition also, the companies can enter or exit freely. The companies will enter when the existing companies are making super-normal profits. With the entry of new companies, the supply would increase which would reduce the price and hence the existing companies will be left only with normal profits. Similarly, if the existing companies are sustaining losses, some of the marginal companies will quit. It will reduce the supply due to which price would rise and the existing companies will be left only with normal profit. Independent decision-making Each MC company independently sets the terms of exchange for its product. The company gives no consideration to what effect its decision may have on its competitors. Market power also means that an MC company faces a downward sloping demand curve. In the long run, the demand curve is very elastic, meaning that it is sensitive to price changes, although it is not completely "flat". In the short run, economic profit is positive, but it approaches zero in the long run. Imperfect information No other sellers or buyers have complete market information, like market demand or market supply. ==Inefficiency==

There are two sources of inefficiency in the MC market structure. The first source of inefficiency is that, at its optimum output, the company charges a price that exceeds marginal costs. The MC company maximises profits where marginal revenue equals marginal cost. Since the MC company's demand curve is downwards-sloping, the company will charge a price that exceeds marginal costs. The monopoly power possessed by a MC company means that at its profit-maximising level of production, there will be a net loss of consumer (and producer) surplus. The second source of inefficiency is the fact that MC companies operate with excess capacity. That is that the MC company's profit-maximising output is less than the output associated with minimum average cost. Both an MC and PC company will operate at a point where demand or price equals average cost. For a PC company, this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average cost. An MC company's demand curve is not flat but is downward-sloping. Thus, the demand curve will be tangential to the long-run average cost curve at a point to the left of its minimum. The result is excess capacity. Socially undesirable aspects compared to perfect competition • Selling costs: Producers under monopolistic competition often spend substantial amounts on advertising and publicity. Much of this expenditure is wasteful from the social point of view. The producer can reduce the price of the product instead of spending on publicity. • Excess capacity: Under imperfect competition, the installed capacity of every firm is large but not fully used. Total output is, therefore, less than the output which is socially desirable. Since production capacity is not fully used, the resources lie idle. Therefore, the production under monopolistic competition is below the full capacity level. • Unemployment: Idle capacity under monopolistic competition expenditure leads to unemployment. In particular, unemployment of workers leads to poverty and misery in the society. If idle capacity is fully used, the problem of unemployment can be solved to some extent. • Cross transport: Under monopolistic competition expenditure is incurred on cross transportation. If the goods are sold locally, wasteful expenditure on cross transport could be avoided. • Lack of specialization: Under monopolistic competition, there is little scope for specialization or standardisation. Product differentiation practised under this competition leads to wasteful expenditure. It is argued that instead of producing too many similar products, only a few standardised products may be produced. This would ensure better allocation of resources and would promote the economic success of the society. • Inefficiency: Under perfect competition, an inefficient company is thrown out of the industry. But under monopolistic competition, inefficient companies continue to survive. ==Problems==

Monopolistically-competitive companies are inefficient, it is usually the case that the costs of regulating prices for products sold in monopolistic competition exceed the benefits of such regulation. A monopolistically-competitive company might be said to be marginally inefficient because the company produces at an output where average total cost is not a minimum. A monopolistically competitive market is a productively inefficient market structure because firms do not produce at the minimum of their average total cost (ATC) curve. Monopolistically-competitive markets are also allocative-inefficient, as the company charges prices that exceed marginal cost. Product differentiation increases total utility by better meeting people's wants than homogenous products in a perfectly competitive market. ==Examples==

In many markets, such as toothpaste, soap, air conditioning, smartphones and toilet paper, food, producers practice product differentiation by altering the physical composition of products, using special packaging, or simply claiming to have superior products based on brand images or advertising. ==See also==