What are the important Merits and Demerits of Monopolistic Competition?

Merits of Monopolistic Competition:

1. An important merit of monopolistic competition is that it is much closer to reality than several other models of market structure. Firstly, it incorporates the facts of product differentiation and selling costs. Secondly, it can be easily used for the analysis of duopoly and oligopoly.

2. Under monopolistic competition it is possible to see that even when each individual firm produces under conditions of increasing returns, not only the firm under consideration but also the entire group of firms can be in equilibrium.

3. Moreover, monopolistic competition is able to show that even when each individual firm is producing under increasing returns, it still earns only normal profit in the long run.

4. The theory of monopolistic competition helps us in bringing in the concept of market share of an individual firm. This opens up the possibility of considering those situations in which a firm may be pursuing a goal other than profit maximization.

5. In monopolistic competition we are able to consider the interaction between several interdependent variables on the basis of which a firm takes its decisions.

Demerits of Monopolistic Competition:

1. The biggest conceptual difficulty with monopolistic competition is the concept of age group of firms. There is no standard theoretical foundation for deciding the boundaries of a group.

2. Related with the concept of a group of firms, we face the difficulty of defining the meaning of a ‘close substitute’. We are not told at what values of cross elasticity, two products become close substitutes of each other.

3. The theory of monopolistic competition fails to take into account the fact that the demand by final consumers is largely influenced by the retail dealers because the consumers themselves are not fully aware of the technical qualities of the product.

4. Similarly, the theory fails to fully account for the determination of equilibrium quantities and prices of goods like raw materials and other inputs. To a large extent, their demand is governed by a combination of the technical quality, price and timely availability rather than by brand name, etc. Given the technical quality of an input, its demand is governed more by its price and availability than its brand name.