The concept of monopolistic competition is more realistic than perfect competition and pure monopoly. According to Chamberlain in real economic situation both monopoly and competitive elements are present. Chamberlain’s monopolistic competition is the blending of competition and monopoly. The most distinguishing feature of monopolistic competition is that the products of various firms are not identical but different although they are close substitutes for each other. Like perfect competition there are a large number of firms but unlike perfect competition the firms produce differentiated products which are close substitutes of each other.
Under monopolistic competition there is freedom of entry and exit. Thus under monopolistic competition it is found that both the features of competition and monopoly are present. In India, for example, we find the monopolistic competition. In India there are a number of manufacturers producing different brands of tooth paste viz Colgate, Pepsodent. Promise, Close-up, Prudent and Forhans etc.
The manufacturer of Colgate has got the monopoly of producing it. Nobody can produce and sell tooth paste with the name Colgate. But at the same time he faces competition from other manufactures of tooth paste as their products are close substitutes of Colgate tooth paste. Thus we find that monopolistic competition is the real market structure than either pure competition or monopoly.
Important features of monopolistic competition
1. Existence of large number of firms:
The first important feature of monopolistic competition is that there is a large number of firms satisfying the market demand for the product. As there are a large number of firms under monopolistic competition, there exists stiff competition between them. These firms do not produce perfect substitutes. But the products are close substitute for each other.
(2) Product differentiations:
The various firms under monopolistic competition bring out differentiated products which are relatively close substitutes for each other. So their prices cannot be very much different from each other. Various firms under monopolistic competitors compete with each other as the products are similar and close substitutes of each other. Differentiation of the product may be real or fancied.
Real or physical differentiation is done through differences in materials used, design, color etc. Further differentiation of a particular product may be linked with the conditions of his sale, the location of his shop, courteous behaviour and fair dealing etc.
(3) Some influence over the price:
As the products are close substitutes of others any reduction of price of a commodity by a seller will attract some customers of other products. Thus with a fall in price quantity demanded increases. It therefore, implies that the demand curve of a firm under monopolistic competition slopes downward and marginal revenue curve lies below it.
Thus under monopolistic competition a firm cannot fix up price but has influence over price. A firm can sell a smaller quantity by increasing price and can sell more by reducing price. Thus under monopolistic competition a firm has to choose a price-output combination that will maximize price.
(4) Absence of firm's interdependence:
Under oligopoly, the firms are dependent upon each other and can't fix up price independently. But under monopolistic competition the case is not so. Under monopolistic competition each firm acts more or less independently. Each firm formulates its own price-output policy upon its own demand cost.
(5) Non-price competition:
Firms under monopolistic competition incur a considerable expenditure on advertisement and selling costs so as to win over customers. In order to promote sale firms follow definite -methods of competing rivals other than price. Advertisement is a prominent example of non-price competition.
The advertisement and other selling costs by a firm change the demand for his product. The rival firms compete with each other through advertisement by which they change the consumer's wants for their products and attract more customers.
(6) Freedom of entry and exit:
In a monopolistic competition it is easy for new firms to enter into an existing firm or to leave the industry. Lured by the profit of the existing firms new firms enter the industry which leads to the expansion of output. But there exists a difference.
Under perfect competition the new firms produce identical products, but under monopolistic competition, the new firms produce only new brands of product with certain product variation. In such a law the initial product faces competition from the existing well- established brands of product.