Monopolistic Competition: 3 Examples of Monopolistic Markets

Monopolistic competition is a market structure where a large number of firms produce similar, though not interchangeable, products. In economics, this type of competitive market falls between monopoly and perfect competition. A monopoly occurs when one firm holds all of the market power and sets the market price. Perfect competition is a theory in which companies make products that are perfect substitutes for each other and buyers have perfect information about the market.

Consider some of the characteristics of monopolistic competition.

1. 1. A large number of firms: In this type of imperfect market, several firms compete for a market share with no single firm monopolizing the market.
2. 2. Product differentiation: In monopolistic competition, each firm produces goods or services that are close substitutes for the goods or services produced by other firms. Competitive firms differentiate their similar products with distinct marketing strategies, brand names, and slightly different quality levels. Product differentiation enables firms to command higher prices for lower quantities of goods.
3. 3. Low barriers to entry: In a monopolistic market, new firms have low barriers to enter the market. Entrants can also exit the market with relative ease.
4. 4. Pricing: Existing firms within this type of imperfect competition act as price makers and set prices for goods and services. Firms in monopolistic competition can lower prices without inciting a price war, a common problem in oligopolies. When marginal revenue equals marginal cost, firms in a monopolistic market achieve profit maximization. As more firms enter a market, the elasticity of the demand curve increases, making the quantities of a product sold more responsive to a price change.

To learn more about how monopolistic competition works in the real world, consider some of these examples.

1. 1. Grocery stores: Grocery stores exist within a monopolistic market as there are a large number of firms that sell many of the same goods but with distinct branding and marketing.
2. 2. Hotels: Hotels offer a prime example of monopolistic competition. Each hotel company offers a similar service with slight variations in pricing and quality levels.
3. 3. Clothing stores: Another example of a large number of firms competing for market share, general clothing stores offer differentiated products that are typically very similar.

Consider some of the advantages of monopolistic competition.

1. 1. Consistent quality of products or services: Monopolistically competitive industries require firms to create slightly different products that compete for market share. For an individual firm to succeed, it must maintain a certain level of quality compared to its competitors.
2. 2. Multiple choices for consumers: Although consumers in monopolistic markets may have imperfect information influencing their buying decisions, they have several options to research before making a purchase.
   
3. 3. Decision-making power: In monopolistic competition, firms have decision-making power over when to enter and exit the market, how to set their prices, and how to market their products. With a large number of firms in the market, an individual firm has the freedom to make decisions without setting off a chain reaction.

There are also disadvantages to monopolistic competition.

1. 1. Inefficiency: In monopolistic competition, firms often operate with excess capacity, meaning they are producing less than they are capable of producing. In this way, firms in a monopolistic market run the risk of being productively inefficient and creating allocative inefficiencies, or a mismatch between output and buyer need.
2. 2. Long-term normal profit: In the short run, firms in monopolistic competition experience positive economic profit. However, in the long run, a firm typically experiences zero economic profit, or normal profit, where its total cost is equal to its total revenue.
3. 3. Waste: Firms operating in monopolistic markets are incentivized to differentiate their products. This can lead to waste in the form of excess packaging or marketing materials with no utility.

Get the MasterClass Annual Membership for exclusive access to video lessons taught by the world’s best, including Paul Krugman, Doris Kearns Goodwin, Ron Finley, Jane Goodall, and more.