Monopolistic competition refers to competition among a large number of sellers of similar but differentiated products which means that the products sold by different firms are close, but not perfect, substitutes for one another.
The number of buyers and sellers in the ‘group’ is sufficiently large.
The goods offered by different producers though different are close substitutes.
There is freedom of entry (freedom to produce substitutes) and exit of firms in the ‘group’.
The sole object of the firm is to maximize profits both in the short-run and in the long run.
The firm operates with the belief that it definitely possesses information regarding the demand curve of its product and the cost curve.
The long-run is constituted of several short periods which are free from one another.
Q . Product differentiation is the basic condition giving rise to monopolistic competition. Explain. Under monopolistic competition, sellers are numerous but no one of them is in a position to control a major part of the supply of the common commodity, which all of them are offering for sale. But each seller so differentiates his portion of the supply of that commodity From the portions sold by others that buyers hesitate to shift their purchases to other in response to price differences. Products like toothpastes, soaps, cigarettes, scooters, photo-copiers, computers, etc. are subject to a large degree of product differentiation. So long as a consumer has an impression that the product brand is different and superior to others, he will be willing to pay more for that brand than for any other brand of the same commodity.
Retailers often price certain items at very low levels to attract large numbers of extra customers to their stores/shops thereby expanding their sales of higher prices items and adding to their total profits.
The items sold at lower prices are known as loss leaders.
1.A large number of customers are able to try out various items at throw away prices. If the product turns out to be good and acceptable to the customer, he may come back to buy it even at regular prices, thus increasing the demand for the product.
2.On the other hand, it helps the draw more number of customers, who get an opportunity to check, inspect various other products of the company, and make their purchase decisions. The producer is thus able to mop up the surplus money available with the customer.
Economic theory suggests that a firm should set its price MR = MC. In practice it is not possible to determine the price in this manner. Firms, therefore adopt a simple method by adding a ‘marking up’ over costs. Markups differ from product to product, firm to firm and industry to industry.
Mark up can be calculated as a percentage increase over average cost or simple as a difference between the price and average cost.
Retailers often resort to this sort of pricing. They assign special roles to various products they sell. Some items may be used as promotional items which are priced and advertised with the prime purpose of attracting customers into the store; others may be intended to make up for the low margin obtained on promotional items.
Market price basis: Under this method, the market price of the commodity transferred is applied for invoicing. The items of expenditure not incurred such as selling, advertising, transportation etc. are reduced from the market price.
Cost basis : Where a market price cannot be determined, such as repair services rendered, it is taken at cost. The draw back is that it cannot establish the efficiency or inefficiency of the department in rendering the service.
Cost-plus basis. Under this method, the goods or services of each department are charged on the basis of actual cost plus a margin by way of profit.
Difference between Perfect Competition and Monopolistic Competition
It is a myth.
Products are homogenous
Market price is the same for all producers.
Advertisement does not help.
It is fact of life.
Products are differentiated.
There are different prices for differentiated products.
Advertisement is necessary to sustain monopolistic competition.