Monopolistic competition describes a market or industry where there are large numbers of firms producing (selling) products that consumers believe are close but not perfect substitutes for each other.
Characteristics of Monopolistic Competition
- Larger Market or Firms in the Industry: There are many small firms each supplying only a small share of the total market output. Hence, no firm has any perceptible influence on the price and output decisions of other firms in the industry.
- Product Differentiation: The firms supply products that are differentiated i.e. similar but not identical. Therefore, each firm has some degree of market power, especially some discretion as to what price to charge for its products.
- Freedom of Entry and Exit of Firms: Barriers to entry are relatively small or non-existent, and productive resources are highly mobile. Product differentiation tends to facilitate the entry of new firms in the industry.
- Nature of Demand Curve: The demand curve for each firm’s product is downward sloping and highly price elastic due to the large number of close substitutes. Price must be lowered to sell a large quantity hence; MR curve also slopes downward and falls below the demand curve.