What is Monopolistic Competition?

Monopolistic Competition Definition

Monopolistic competition describes an industry in which many firms are offering products that are similar, but not perfect substitutes.

In this type of industry, decisions of one firm will not directly affect their competitors, so it is said that firms have a low degree of market power.

Because products are broadly similar to one another, firms need to distinguish their product through heavy marketing.

This marketing focuses on product differentiation from similar products, which potentially comes by way of a discounted price or improved product branding, for example.

Barrier to entry in a monopolistic competition is low, which creates an incentive for new firms to enter the market and increase competition.

Because there is a range of similar products, demand is said to be ‘highly elastic’ in a monopolistic competition, that is, very sensitive to price changes.

A good example of this is with a consumer staple item such as cleaning products.

If the price of a specific brand of surface cleaner rises by 15%, there is a good chance the consumer will switch to a different and less expensive brand, or an alternative soap or disinfectant, with little hesitation.

In the short run, economic profit is positive in this industry, but approaches zero in the long run.

Economic profit is defined as the difference between the revenue from a sale and all of the costs used to create that product and sale, as well as any opportunity costs.

Monopolistic Competition Key Points

  • Monopolistic competition describes an industry that has similar products, but not perfect substitutes for one another
  • Firms in a monopolistic competition have a low degree of market power, that is, one firm’s decisions will not directly affect other competitors.
  • All firms in a monopolistic competition are price makers, and demand is very sensitive to price changes, or “highly elastic.”
  • Barrier to entry in this type of industry is low, which creates an incentive for increased competition.
  • Monopolistic competition usually includes industries that many consumers are familiar with in their daily lives, such as clothing stores, restaurants, and convenience stores.