Advantages and Disadvantages of Monopolistic Competition

Every market has features that distinguish it from others, it also has inherent pros and cons for producers and consumers. Like other types of market structures, monopolistic competition has features, advantages, and disadvantages.

The advantages and disadvantages of monopolistic competition include access to a wide range of products, low entry barriers, and the ability to set prices as advantages. Reduced profits, inefficient production, and lack of perfect information as disadvantages.

Aside from these advantages and disadvantages of monopolistic competition, we shall discuss additional ones after we understand monopolistic competition and consider its features.

See also: Monopolistic Market Structure: Types and Examples

What is monopolistic competition?

Monopolistic competition refers to one of the four types of market structures. This market structure was first identified in 1933 by American economist, Edward Hastings Chamberlin and  British economist Joan Robinson.

The market is characterized by the presence of many buyers and sellers. These sellers (companies) sell similar products or services that are differentiated by price, quality, or branding, hence, the products are not perfect substitutes.

The differentiation of products is one of the methods used by sellers to stand out from their competition, attract more customers, make more sales, and consequently earn more profits.

Most existing markets today are monopolistic competition as no single seller can alter market price since they are not the only producers and do not have complete market power. Instead, each producer can only determine their selling price because they only have a fraction of the market share.

Companies that can highly differentiate their products and appeal to more consumers tend to charge a higher price as they position themselves as providing better products or services. They may also enjoy a considerable amount of consumer loyalty especially if they have operated in the industry for a long time.

Advantages and disadvantages of monopolistic competition
Monopolistic competition advantages and disadvantages

See also: Traditional Economy Advantages

Features of monopolistic competition

  1. Highly elastic demand
  2. Limited market share and power
  3. Low market entry and exit barriers
  4. Many competing companies
  5. Product differentiation

Highly elastic demand

The elastic nature of demand is one of the key features of monopolistic competition. This means that consumer demand for goods and services is price sensitive and consumers will change from one brand to another due to price increases.

For example, if a bottled water brand changes its price from $1 to $2, some of its customers will start patronizing another bottled water brand that charges $1.

Due to the price elasticity in a monopolistic market, the demand curve for each company is downward sloping. It indicates that consumers want to pay less for products and services as more competing brands produce similar goods.

The increased competition as more companies enter the market reduces the profits each producer makes. Thus, in the long run, companies that operate under monopolistic competition earn a normal profit which is enough to cover their costs, but not enough to earn an economic profit.

Limited market share and power

Unlike a monopoly where a single producer has the whole market share and therefore has market power, in a monopolistic competition, each existing producer has a fraction of the market share and their market power is only applicable to the goods or services they provide.

This means that each company is a price maker that can set the price for its goods and services but they cannot affect the overall market price.

Additionally, the ability to change price is quite limited since a sharp price increase is likely to lead to a loss of a significant portion of customers as they will switch to a competing brand.

Therefore, all companies that exist under monopolistic competition compete with each other to have a share of the market. Hence, the limited market share and power is a feature of monopolistic competition.

Low market entry and exit barriers

Low market entry and exit barriers are another major characteristic of monopolistic competition. This means that new firms can join the market without many challenges and existing firms can equally exit the market when they deem fit.

The low entry and exit barriers under monopolistic competition ensure that consumers consistently have access to a variety of products and services.

For instance, while an existing bakery may shut down due to decreased patronage, another bakery is likely to spring up offering similar products that are slightly differentiated by the ingredients they use.

In essence, producers do not need to consider how their decisions influence their competitors since each brand has the liberty to exit the market at any time and new entrants can enter the market too. Therefore, under monopolistic competition, entry and exit barriers are low.

Many competing companies

Another feature of monopolistic competition is the presence of many competing companies that produce similar goods. In every industry, several brands compete with each other to reach more consumers and gain more revenue.

Some industries where monopolistic competition is evident include the automobile, hospitality, retail, clothing, cosmetic, fast-food, and hair salons amongst many others.

Product differentiation

A visit to any supermarket will present one with similar goods made by different brands such as toothpaste, detergent, processed meat, diapers, infant formula, water, etc.

Aside from the difference in brand name, there may also be differences in quality, raw materials used, design, packaging, and other visible features. They may also have a different approach to marketing and customer relations.

See also: Disadvantages of Socialist Economy

Advantages of monopolistic competition

  1. Few barriers to entry for new companies
  2. Company decision-making power for prices and marketing
  3. Consistent quality of product for consumers
  4. Encourages innovation
  5. Variety of choices for consumers

Few barriers to entry for new companies

One of the advantages of monopolistic competition is the few entry barriers that new companies face when compared to the insurmountable entry barriers in a monopoly.

Due to this low entry barrier, more people and entities can turn their ideas into valuable businesses that contribute meaningfully to the diversity of products and services available in the market.

For instance, a lady who knows how to braid but does not have the resources to outrightly open a salon can easily start a braiding business in the comfort of her home. This is possible due to the low entry barriers in monopolistic competition.

Company decision-making power for prices and marketing

Another monopolistic competition advantage for producers is that they have the liberty to decide the price they will charge for their products as well as the quantity they will produce based on production costs and demand.

For instance, they could use the cost-plus pricing strategy where they add a particular percentage to the cost of production as their selling price or they could use the skimming pricing strategy where they charge the highest possible price at the beginning and reduce the price gradually over time.

This means a brand can choose any of the types of pricing strategies that align with its overall business plan and implement them.

Brands also have the power to decide on the kind of marketing strategy they will use such as SMS, email, social media, or other traditional marketing methods.

Consistent quality of product for consumers

The consistent quality of products is an additional advantage of monopolistic competition. This is made possible due to the high rate of competition that exists in the market.

In a bid to maintain patronage and attract new customers, most companies ensure that their products have a consistent quality over time so that they can win the confidence and patronage of consumers thereby generating higher revenue.

Encourages innovation

One of the major monopolistic competition advantages is that it encourages innovation. Companies continually reinvent existing products and even create new ones to further differentiate their brand and products.

The drive towards innovation is equally beneficial to consumers as they get access to more improved products over time.

For instance, the drive towards the sustainable use of resources and environmental protection has led to the gradual abandonment of plastic packaging and the adoption of biodegradable packaging. As more companies embrace innovation, consumers keep benefiting.

Aside from product innovation, other customer-centric approaches such as improved customer service and consumer reward schemes have been adopted by a significant number of companies that operate in a monopolistic competition market.

Variety of choices for consumers

The presence of many competing firms serves as an advantage of monopolistic competition as it aids the availability of a diversity of products for consumers.

Each of these products often has a unique feature that differentiates them thereby making it easier for consumers to get products that fit their personal preferences more closely.

For instance, while most burger producers focused on making beef burgers, Chick-fil-A created an alternative, chicken burgers, for consumers who did not want beef burgers.

In addition, the availability of diverse similar products can lead to access to low-priced, high-quality products due to new entrants and increased competition.

See also: Advantages of a Command Economy

Disadvantages of a monopolistic competition

  1. Economies of scale are limited
  2. Lack of perfect information
  3. Misleading advertising
  4. Reduced profits
  5. Too many options for consumers

Economies of scale are limited

The presence of several competing firms limits the possibility of particular companies achieving economies of scale. Since the existing companies produce similar goods, they are likely to have similar purchasing power.

This implies that a company cannot influence the price of raw materials or purchase them at a lower rate from suppliers. Therefore, companies that operate within the same industry are likely to earn similar revenue since they are likely to price their products within the same range.

For example, the different brands of toothpaste sold in the United Kingdom are often priced between £1.00 to £5.00

Lack of perfect information

The similarities in the available products in a monopolistic competitive market often lead to a lack of perfect information on the products. This is another disadvantage of this kind of market structure.

For instance, most people cannot articulate the difference between the various detergent brands that are available in the market. This also applies to other products such as shoes, clothes, and other daily essentials. Due to this, consumers are often unable to make informed choices when they make purchases.

Misleading advertising

An additional disadvantage of monopolistic competition is misleading advertising. Due to the high dependence of most company sales on advertising and consumer perception, some brands may get involved in misleading advertising to attract more customers.

For instance, a company may use a “buy-one-get-one-free” advert to attract customers, when in fact, the consumer pays for both products.

Reduced profits

Reduced profits in the long run is another monopolistic competition disadvantage. As more companies join the market, demand reduces since some consumers will start patronizing the new companies.

The cost of differentiating products could also increase the cost of production and reduce the efficient allocation of resources. All these contribute to reducing the amount of profit that could be realized by a firm which is one of the disadvantages of monopolistic competition.

Too many options for consumers

The sheer number of available products and service variety can also be a challenge for consumers as they will spend more time deciding on the particular brand to purchase.

For example, when a person wants to buy cornflakes, detergent, soap, and milk, they are met with a variety of brands producing these products. Since most consumers cannot tell the differences between the brands due to a lack of perfect information, choosing what brand to use becomes time-consuming and cumbersome.

See also: Mixed Economy Disadvantages

Summary of the advantages and disadvantages of monopolistic competition

AdvantagesDisadvantages
The entry barriers for new companies are minimalEconomies of scale are limited
Companies are at liberty to decide the price they will charge for their products and services Lack of perfect information on products
The high level of competition leads to consistency in product qualityMisleading advertising to attract customers
Monopolistic competition spurs innovationReduced profits as more companies join the market
Consumers have access to a variety of products and servicesConsumers become confused due to too many available options
Table summarizing the advantages and disadvantages of monopolistic competition

See also: Mixed Economy Advantages

Conclusion

Every market consists of both benefits and drawbacks. Some benefits of monopolistic competition include low entry barriers, variety of products, increased innovation, consistency in product quality, and price-making ability of firms.

Drawbacks of monopolistic competition include reduced profits, lack of perfect information on products, option overload, low economies of scale, and misleading advertising.

Despite these disadvantages, monopolistic competition is one of the top market structures operated all over the globe due to the many advantages it presents.