The competitive aspect of monopolistic competition lies in the fact that in this model, a large number of producers compete with each other in producing and selling close-substitute products belonging to a product-group, and there is also a large number of buyers competing for buying the products.
On the other hand, the monopolistic aspect of monopolistic competition lies in the fact that here any firm is the sole producer of its product which belongs to the product-group. If all the firms produce and sell an identical good, then the control of any one firm over the price of the product is completely eliminated.
This happens in the case of perfect competition. But in monopolistic competition, the firms produce close-substitute products and so here the control of a firm over the price of its product is not completely eliminated. Here a firm has some control, although very limited, over the price of its product.
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This is the monopolistic aspect of monopolistic competition. Because of this aspect, the AR curve of a firm under monopolistic competition would be negatively sloped like that of a monopolist. For example, under monopolistic competition, a firm may increase the price of its product (by a small amount) and, yet, its sales will not fall to zero.
For, there will always be some buyers ready to pay a higher price for the product, because it is somewhat different from other products, and just because of this difference, they have a special liking for the product.
On the other hand, a firm under monopolistic competition is the sole producer of its product. That is why, unlike perfect competition it cannot sell a larger quantity at the same price. If it wants to sell a larger quantity per period, it would have to reduce the price of its product. (We are assuming here that the firm’s advertisement expenditures remain unchanged).
But the competitive aspect of monopolistic competition having a large number of buyers and sellers has a very important implication. If the firm here increases the price of its product, the quantity sold will fall—this is because of the monopolistic aspect. But it will fall considerably—this is because of the competitive aspect.
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Many of the buyers will switch over to the close-substitute products as the price of the firm’s product rises. On the other hand, if the firm lowers the price of its product by a small amount, the prices of the rival products remaining unchanged, the quantity demanded of its product would rise considerably. For now many of the buyers of the substitute products will prefer buying its product.
It follows from the above discussion that the ‘perceived’ demand curve for the product of a firm under monopolistic competition would slope downward towards right because of the monopolistic aspect, but it would be highly elastic because of the competitive aspect.
Another competitive aspect of monopolistic competition is that, as under perfect competition, here also in the long run, the new firms may join the industry, or rather the group, if the existing firms earn excess profit in the short run; and if they earn less than normal profit, they may leave the group.
This competitive aspect of monopolistic competition implies that in the long run the perceived AR curve of each firm would be shifting leftwards or rightwards as the firms join or leave the group, till it becomes tangent to the LAC curve.
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In other words, in the long run the firms under monopolistic competition earn just the normal profit—nothing more or nothing less. But because of the monopolistic aspect of the downward sloping AR curve, the tangency occurs not at the minimum point of the LAC curve, but to the left of this point.
This means that the long-run output of each firm under monopolistic competition would be less and the price of the product more than those under perfect competition. This is a monopolistic aspect. The monopolistic and the competitive aspects of monopolistic competition. We may conclude that monopolistic competition is more like competition than monopoly.