When p > mc in a monopolistically competitive market, that industry will most likely produce

A type of market structure where companies in an industry produce similar but differentiated products

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Industries Exhibiting Features of Monopolistic Competition
Short-Run Decisions on Output and Price
Long-Run Decisions on Output and Price
Monopolistic Competition vs. Perfect Competition
Inefficiencies in Monopolistic Competition
Limitations of Monopolistic Competition Market Structure
Additional Resources

Monopolistic competition is a type of market structure where many companies are present in an industry, and they produce similar but differentiated products. None of the companies enjoy a monopoly, and each company operates independently without regard to the actions of other companies. The market structure is a form of imperfect competition.

The characteristics of monopolistic competition include the following:

The presence of many companies
Each company produces similar but differentiated products
Companies are not price takers
Free entry and exit in the industry
Companies compete based on product quality, price, and how the product is marketed

Companies in a monopolistic competition make economic profits in the short run, but in the long run, they make zero economic profit. The latter is also a result of the freedom of entry and exit in the industry. Economic profits that exist in the short run attract new entries, which eventually lead to increased competition, lower prices, and high output.

Such a scenario inevitably eliminates economic profit and gradually leads to economic losses in the short run. The freedom to exit due to continued economic losses leads to an increase in prices and profits, which eliminates economic losses.

In addition, companies in a monopolistic market structure are productively and allocatively inefficient as they operate with existing excess capacity. Because of the large number of companies, each player keeps a small market share and is unable to influence the product price. Therefore, collusion between companies is impossible.

In addition, monopolistic competition thrives on innovation and variety. Companies must continuously invest in product development and advertising and increase the variety of their products to appeal to their target markets. Competition with other companies is thus based on quality, price, and marketing.

Quality entails product design and service. Companies able to increase the quality of their products are, therefore, able to charge a higher price and vice versa. Marketing refers to different types of advertising and packaging that can be used on the product to increase awareness and appeal.

Industries Exhibiting Features of Monopolistic Competition

Examples of industries in monopolistic competition include the following:

Clothing and apparel
Sportswear products
Restaurants
Hairdressers
PC manufacturers
Television services

Short-Run Decisions on Output and Price

The short-run equilibrium under monopolistic competition is illustrated in the diagram below:

Profits are maximized where marginal revenue (MR) is equal to marginal cost (MC). The point determines the company’s equilibrium output. The price is determined at a point where the imaginary line from the equilibrium output passes through the point of intersection of the MR, and MC curves and meets the average revenue (AR) curve, which is also the demand curve.

Total profit is represented by the cyan-colored rectangle in the diagram above. It is determined by the equilibrium output multiplied by the difference between AR and the average total cost (ATC). Companies in monopolistic competition determine their price and output decisions in the short run, just like companies in a monopoly.

Companies in monopolistic competition can also incur economic losses in the short run, as illustrated below. They still produce equilibrium output at a point where MR equals MC in which losses are minimized. The cyan-colored rectangle shows the economic loss incurred.

Long-Run Decisions on Output and Price

In the long run, companies in monopolistic competition still produce at a level where marginal cost and marginal revenue are equal. However, the demand curve will have shifted to the left due to other companies entering the market. The shift in the demand curve is a result of reduced demand for an individual company’s products due to increased competition.

Such an action reduces economic profits, depending on the magnitude of the entry of new players. Individual companies will no longer be able to sell their products at above-average cost.

Companies in monopolistic competition will earn zero economic profit in the long run. At this stage, there is no incentive for new entrants in the industry.

Monopolistic Competition vs. Perfect Competition

Companies in monopolistic competition produce differentiated products and compete mainly on non-price competition. The demand curves in individual companies for monopolistic competition are downward sloping, whereas perfect competition demonstrates a perfectly elastic demand schedule.

However, there are two other principal differences worth mentioning – excess capacity and mark-up. Companies in monopolistic competition operate with excess capacity, as they do not produce at an efficient scale, i.e., at the lowest ATC. Production at the lowest possible cost is only completed by companies in perfect competition.

Mark-up is the difference between price and marginal cost. There is no mark-up in a perfect competition structure because the price is equal to marginal cost. However, monopolistic competition comes with a product mark-up, as the price is always greater than the marginal cost.

Inefficiencies in Monopolistic Competition

The equilibrium output at the profit maximization level (MR = MC) for monopolistic competition means consumers pay more since the price is greater than marginal revenue.
As indicated above, monopolistic competitive companies operate with excess capacity. They do not operate at the minimum ATC in the long run. Production capacity is not at full capacity, resulting in idle resources.
Monopolistic competitive companies waste resources on selling costs, i.e., advertising and marketing to promote their products. Such costs can be utilized in production to reduce production costs and possibly lower product prices.
Since companies do not operate at excess capacity, it leads to unemployment and social despondency in society.
Inefficient companies continue to exist under monopolistic competition, as opposed to exiting, which is associated with companies under perfect competition.
Another scope of inefficiency for monopolistic competitive markets stems from the fact that the marginal cost is less than the price in the long run.
Monopolistic competitive market structures are also allocatively inefficient. Their prices are higher than the marginal cost.

Limitations of Monopolistic Competition Market Structure

Companies with superior brands and high-quality products will consistently make economic profits in the real world.
Companies entering the market will take a long time to catch up, and their products will not match those of the established companies for their products to be considered close substitutes. New companies are likely to face barriers to entry because of strong brand differentiation and brand loyalty.

Additional Resources

Thank you for reading CFI’s guide to Monopolistic Competition. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

Monopolistic competition exists when many companies offer competing products or services that are similar, but not perfect, substitutes.

The barriers to entry in a monopolistic competitive industry are low, and the decisions of any one firm do not directly affect its competitors. The competing companies differentiate themselves based on pricing and marketing decisions.

Monopolistic competition occurs when many companies offer products that are similar but not identical.
Firms in monopolistic competition differentiate their products through pricing and marketing strategies.
Barriers to entry, or the costs or other obstacles that prevent new competitors from entering an industry, are low in monopolistic competition.

Monopolistic competition exists between a monopoly and perfect competition, combines elements of each, and includes companies with similar, but not identical, product offerings.

Restaurants, hair salons, household items, and clothing are examples of industries with monopolistic competition. Items like dish soap or hamburgers are sold, marketed, and priced by many competing companies.

Demand is highly elastic for goods and services of the competing companies and pricing is often a key strategy for these competitors. One company may opt to lower prices and sacrifice a higher profit margin, hoping for higher sales. Another may raise its price and use packaging or marketing that suggests better quality or sophistication.

Companies often use distinct marketing strategies and branding to distinguish their products. Because the products all serve the same purpose, the average consumer often does not know the precise differences between the various products, or how to determine what a fair price may be.

In monopolistic competition, one firm does not monopolize the market and multiple companies can enter the market and all can compete for a market share. Companies do not need to consider how their decisions influence competitors so each firm can operate without fear of raising competition.

Competing companies differentiate their similar products with distinct marketing strategies, brand names, and different quality levels.

Companies in monopolistic competition act as price makers and set prices for goods and services. Firms in monopolistic competition can raise or lower prices without inciting a price war, often found in oligopolies.

Demand is highly elastic in monopolistic competition and very responsive to price changes. Consumers will change from one brand name to another for items like laundry detergent based solely on price increases.

Monopolistic competition provides both benefits and pitfalls for companies and consumers.

Pros

Few barriers to entry for new companies
Variety of choices for consumers
Company decision-making power for prices and marketing
Consistent quality of product for consumers

Cons

Many competitors limits access to economies of scale
Inefficient company spending on marketing, packaging and advertising
Too many choices for consumers means extra research for consumers
Misleading advertising or imperfect information for consumers

In perfect competition, the product offered by competitors is the same item. If one competitor increases its price, it will lose all of its market share to the other companies based on market supply and demand forces, where prices are not set by companies and sellers accept the pricing determined by market activity.

In monopolistic competition, supply and demand forces do not dictate pricing. Firms are selling similar, yet distinct products, so firms determine the pricing. Product differentiation is the key feature of monopolistic competition, where products are marketed by quality or brand. Demand is highly elastic, and any change in pricing can cause demand to shift from one competitor to another.

Companies aim to produce a quantity where marginal revenue equals marginal cost to maximize profit or minimize losses. When existing firms are making a profit, new firms will enter the market. The demand curve and the marginal revenue curve shift and new firms stop entering when all firms are making zero profit in the long run. If existing firms are incurring a loss, some firms will exit the market. The firms stop exiting the market until all firms start making zero profit. The market is at equilibrium in the long run only when there is no further exit or entry in the market or when all firms make zero profit in the long run.

Monopolistic competition is present in restaurants like Burger King and McDonald's. Both are fast food chains that target a similar market and offer similar products and services. These two companies are actively competing with one another, and seek to differentiate themselves through brand recognition, price, and by offering different food and drink packages.

A monopoly is when a single company dominates an industry and can set prices for its product without fear of competition. Monopolies limit consumer choices and control production quantity and quality. Monopolistic competitive companies must compete with others, restricting their ability to substantially raise prices without affecting demand and providing a range of product choices for consumers. Monopolistic competition is more common than monopolies, which are discouraged in free-market nations.

Monopolistic competition exists when many companies offer competitive products or services that are similar, but not exact, substitutes. Hair salons and clothing are examples of industries with monopolistic competition. Pricing and marketing are key strategies for competing companies and often rely on branding or discount pricing strategies to increase market share.