In Monopolistic Competition, there are many small firms who all have very small shares of the market. Firms have many competitors, but each one sells a slightly different product. Firms are neither price takers (perfect competition) nor price makers (monopolies).
Example of Monopolistic Competition
The athletic shoe market:
When you walk into a sports store to buy running shoes, you will find a number of brands, like Nike, Adidas, New Balance, ASICS, etc.
i. On one hand, the market for running shoes seems to be full of competition, with thousands of competing brands and low barriers to entry.
ii. On the other hand, its market seems to be monopolistic, due to uniqueness of each shoe brand and power to charge different price.
Characteristics of Monopolistic Competition
Products are differentiated (based on things like service, quality or design). The product of a firm is close, but not perfect substitute of other firm. This gives some monopoly power to an individual firm to influence market price of its product.
Barriers to Entry
Number of Sellers
There are large numbers of firms selling closely related, but not homogeneous products. Each firm acts independently and has a limited share of the market. So, an individual firm has limited control over the market price.
Products are differentiated and these differences are made known to the buyers through advertisement and promotion. These costs constitute a substantial part of the total cost under monopolistic competition.
There is imperfect knowledge in the market. People don’t know who is selling the good the cheapest or who has the best quality. Sometimes a higher priced product is preferred even though it is of inferior quality.