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Monopolistic Competition = Perfect Competition + Monopoly

Perfect competition is characterized by large number of firms selling homogeneous products involving perfectly informed buyers and sellers. This ensures that a single price must prevail under perfect competition and the demand curve facing any firm is perfectly elastic at the ruling market price. Thus the firm does not exercise any control over the price of the product but can sell any amount of output at the ruling price. If it tries to raise its price slightly above the ruling price, it will lose all its customers to the rival firms which are also selling the same homogeneous product at lower market price. Because the firm can sell as much as it wants at the existing market price it has no incentive to lower it because that will lead to loss of revenue ( P*Q). hence it is a single price industry.

In a monopoly there is only a single firm which is faced with the entire market demand. The equality of its marginal cost and marginal revenue will decide its price output combination. Hence it is also a single price industry.

difference between monopoly monopolistic competition

In case of monopolistic competition, there are large numbers of firms that produce closely related but not identical products. Due to product differentiation, the product of each firm has special characteristics adapted to the taste and preferences of the consumers. The qualitative difference in the products leads to a large variation in the cost and demand curves of the firms. The demand curves differ with respect to shape, elasticity while the cost curves differ in shape and positions. As a result of these heterogeneous conditions surrounding each firm there will be differences in price output and profits of various firms in the group. Hence monopolistic competition is a multiprice industry. (Further due to the group behavior and close substitute products the single firm's price and output may affect the decisions of other firms which may change their prices in retaliation. Even this leads to nonexistence of definite price decision.)

The distinguishing feature of monopolistic competition which makes it a blend of monopoly and perfect competition is the product differentiation. Product differentiation means that the products are not homogeneous but differentiated but still are very close substitutes of each other. The products are only slightly different but quite similar and are close substitutes of each other. the product differentiation decide the degree of monopoly as there are large number of firms selling differentiated products each one having a monopoly over its on product. But the economic competition and warfare arises from the products being close substitutes of each other. So each seller is subject to competition of more or less imperfect substitutes as well. The product differentiation is based on a certain characteristic of the product itself like patented features, trademarks, peculiar packaging, quality difference or imaginary differences created through advertising or branding or on the basis of the services and conditions surrounding the sale of product.

Since the products are close substitutes of each other economic competition may be introduced through price competition as well. The demand for the firm’s product will also depend on the nature and price of the close substitutes the price and output decision of the firm will affect his rival firms which may revise their output prices in retaliation as well. So this leads to a general group competition and the prices of the firms can’t be too much variable from each other.

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