Monopolistic competition means an industry in which various companies offer products or services that are similar (but not perfect) substitutes. Barriers to entry and exit in a monopolistic competitive industry are low, and the decisions of any one firm do not directly affect those of its competitors.
- It is a market structure where the number of firms is large, there are free entry and exit of firms, but the goods produced by them are not homogeneous. Firms can differentiate their products. Therefore, they have an inelastic demand curve and so that they can set prices.
- However, because there is freedom of entry, supernormal profits will encourage more firms to enter the market leading to normal profits in the long term.
- For example, there is a very large number of biscuit producing firms. But many of the biscuits being produced are associated with some brand name and are distinguishable from one another by these brand names and packaging and are slightly different in taste.
- The consumer develops a taste for a particular brand of biscuit over time and is, therefore, not immediately willing to substitute it for another biscuit. However, if the price difference becomes large, the consumer would be willing to choose a biscuit of another brand. The price difference required for the consumer to change the brand consumed may vary.
- It is a market structure which combines elements of monopoly and competitive markets.
A monopolistic competitive industry has the following features:
o A large number of firms.
o Freedom of entry and exit.
o Firms produce differentiated products.
o Firms have price inelastic demand; they are price makers because the good is highly differentiated.
o Firms make normal profits in the long run but could make supernormal profits in the short term.