Essay # 1. Meaning of Monopolistic Competition:
Monopolistic competition refers to a market situation where there are many firms selling a differentiated product. “There is competition which is keen, though not perfect, among many firms making very similar products.”
No firm can have any perceptible influence on the price-output policies of the other sellers nor can it be influenced much by their actions. According to Salvatore, “Monopolistic competition refers to the market organisation in which there are many firms selling closely related but not identical commodities.”
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Products are close substitutes with a high cross-elasticity and not perfect substitutes, Tata, Lipton, etc. tea; Hamam, Lux etc. soap; Pepsi, Coca Cola, etc. cold drinks are examples of product differentiation. Under monopolistic competition, no single firm controls more than a small portion of the total output of a product.
As the products are close substitutes, a reduction in the price of a product will increase the sales of the firm but it will have little effect on the price-output conditions of other firms, each will lose only a few of its customers. Likewise, an increase in its price will reduce its demand substantially but each of its rivals will attract only a few of its customers.
Therefore, the demand curve (average revenue curve) of a firm under monopolistic competition slopes downward to the right. It is elastic but not perfectly elastic within a relevant range of price at which he can sell any amount.
It means that it has some control over price due to product differentiation and there are price differentials between firms. Despite this, the slope of the demand curve is determined by the general level of the market price for the differentiated product.
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In so far as it exercises some control over price, it resembles monopoly and since its demand curve is affected by market conditions, it resembles pure competition. Such a situation is, therefore, characterised as monopolistic competition.