Before discussing the intrinsic advantages and disadvantages of monopolistic competition, I believe it is best to firstly gain a brief comprehension and understanding of -- what actually is 'monopolistic competition'? The concept of 'monopolistic competition' was originally defined by Edward Chamberlin and Joan Robinson in the 1930's and is often introduced in first and foundation years of economics, finance and business degrees -- expanding upon the foundation of imperfect competition, whilst highlighting the importance of differentiation of goods and services to enterprises. It describes a market with numerous small independently owned firms such as clothing stores and restaurants, which each pose a sign of 'uniqueness' in how they differentiate themselves to others, but are all in essence competing with one another for the same type of custom.
Moreover, it is usually defined by several important characteristics: there are many firms who operate under a basis of independent decision making, who intend to differentiate their products or services with the intention of taking advantage of their market power in order to profit maximize. However, unlike firms in a perfectly competitive market, a firm operating in a monopolistic competition does not have access to perfect information and the market has low barriers entry and exit (in the long run). For a more detailed overview of what a monopolistic competition is in economic terms and its features -- please check out the video 'what is monopolistic competition' just below as well as the reference at the bottom of the article.
What is Monopolistic Competition?
Advantages of Monopolistic Competition
1. The Promotion of Competition (lack of Barriers to Entry)
In such a market, one of its primary aspects is that there a lack of barriers to entry (factors that cause difficulty for a new firm to enter the market e.g. intellectual property rights, advertising, large start-up costs etc.), hence making it relatively easy for firms to enter (and exit) the market. This therefore ensures (at least in the long run) no 'single firm' will find themselves with monopoly power (and with that -- the ability to exploit consumers), due to new entering firms to the market.
2. Differentiation Brings Greater Consumer Choice and Variety
One of the main positives to come out of a monopolistically competitive market is that in order to be a competitive firm within such a market place, a firm's primary goal is to differentiate itself from others in order to gain greater custom than its rival competitors -- essentially appealing to consumer sovereignty (where consumers determine the goods to be produced within a market). With this, is the provision of greater choice and variety of products and services for consumers to purchase from -- they have a wider range of consumer choice as opposed to just a single choice (either just one product -- monopoly -- or all the products are generic and homogenous -- perfectly competitive).
3. Product and Service Quality - Development
Another potential merit of monopolistic competition, is that of incentives for firms to improve product quality in order to gain (temporary) economic profit -- which in some aspects relates to the above point on some levels. "Monopolistically competitive industries are in a constant state of flux" -- they are always trying to edging on ways to make profit, whether that be by lowering the cost of production or by improving on their product. The process of 'creative destruction' -- the drive to ensure short term gain.
4. Consumers Become More Knowledgable of Products
A positive externality from monopolistic competition and the intense advertising and marketing that accompanies it, is that due to firms trying to differentiate their products -- consumers become more informed and aware of their options regarding such products and services. They can gain an understanding of the unique features and aspects that certain products have compared to that of others. Hence, with this comes further competition, as firms can recognise what consumers are wanting to a better degree.
Disadvantages of Monopolistic Competition
1. They Can be Wasteful -- Liable of Excess Capacity
A negative factor of firms that are in monopolistic competition is that they don't produce enough output to efficiently lower the average cost and benefit from economies of scale. As if they were to do this (as from the graph) they are reducing their 'economic profits', as a result of the marginal revenue being less than that of the marginal cost. Moreover, the funding and expense that goes into packaging, marketing and advertising can deemed extremely wasteful on some levels.
2. Allocatively Inefficient
Compared with perfect competition, it can be shown that such firms (particularly from the video above) that there is an element of allocation efficiency as the price is above that of the marginal cost curve -- less so in the long run, due to more competition. As the demand curve is one which is downward sloping this then implies the price has to be greater than the marginal cost for a monopolistically competitive firm. Hence it is allocatively inefficient as not enough of the product gets produced for society to benefit -- they want more, however this would force the company to lose money.
3. Higher Prices
Another drawback of a monopolistic competition, is that as a result of firms having 'some market power', they can extenuate a mark-up on the marginal cost of revenue. Compared to a perfectly competitive firm, who have their price equal to their marginal cost. Causing a deadweight loss in society as described above. This would be difficult for a governmental authority to regulate for two reasons: i) there are many firms and ii) they would be making a loss -- hence eventually forcing such firms out of business.
Although, as stated earlier, advertising and marketing can be beneficial to consumers on some levels such as providing information to customers and from this an increase in competition, it can also have negative impacts on consumer sovereignty. It is argued to manipulate and distort what consumers desire, as well as obviously reducing competition as consumers become captivated over the perception of differentiation.
Summary of the Advantages and Disadvantages of Monopolistic Competition
Obviously the list above is a rather 'tongue in cheek' attempt and will differ depending on the point of view we take i.e. the pros and cons of monopolistic competition will be different to a consumer than that of a firm in that particular market, also whether we are comparing a monopolistically competitive market with a monopoly/oligopoly market/perfectly competitive market as well as the time frame the 'long run' or the 'short run' --it is important to recognise 'the point of view'.
After assessing both the negatives of a monopolistic competition such as a firm not producing at the lowest possible cost per unit (excess capacity) as well as failing to produce the output wanted from society (allocatively inefficient),with the positive factor of product variety. Then in all, a monopolistic competition it is likely to benefit society as a whole -- due to differing individual tastes and desires that such a market caters for.
If you have any additional advantages and disadvantages of monopolistic competition or any general remarks and considerations you wish to point and share, then I encourage you to please leave a comment below in the comments box.