8.

Monopolistic Competition

It is a form of imperfect competition where many competing producers sell products that are
differentiated from one another. Despite the existence of close substitutes each firm acts
atomistically, ignoring the competitors reactions, because they are too many of them and each
one would be very little affected by the actions of any other competitor.

In A. Koutsoyiannis text he focuses on the Chamberlain model of monopolistic competition

which was based on the following assumptions :

1. There is a large number of sellers and buyers in the group

2. The products of the sellers are differentiated, yet they are close substitutes of one another

3. There is free entry and exit of firms in the group

4. The prices of factors and technology are given

5. The goal of the firm is profit maximization both in the short run and in the long run

6. The firm is assumed to behave as if it knew its demand and cost curves with certainty

7. The long run consists of a number of identical short run periods, which are assumed to be
independent of one another in the sense that decisions in one period do not affect future
periods and are not affected by past actions. Thus by assumptions maximization of short
run profits implies maximization of long run profits

8. Finally Chamberlain makes the heroic assumption that both demand and cost curves for
all products are uniform throughout the groups.

Chamberlin's thought centers on the product. Each producer, under "monopolistic competition,"
faces competition from "substitute" products which are not identical and which are sold by
others. Under "pure" competition (many sellers and a completely standardized product) a
horizontal demand curve (average revenue) would exist for each individual competitor's product.
This would mean identical prices. Chamberlin argues that "pure" competition would force all
individual competitors to treat differential advantages, the same as other costs.
Chamberlin emphasizes the effect of judgments by one seller concerning his rivals' policies,
possible retaliation, etc. He also argues that selling costs such as advertising are not part of the
cost of production, but are incurred to increase the sales of the given product; and thus they
affect the demand curve. Throughout, his basic idea is that, no matter how slight, any
differentiation of a seller's product gives him to that extent a monopoly.

The conclusion is drawn that under monopolistic competition the equilibrium price is higher, and
the volume of output probably lower, than under pure competition. The net profits of enterprise,
however, may or may not be higher than under pure competition because of the expense which is
required to maintain the monopoly elements and which is often increased by a multiplication of
substitute products surrounding the monopolist. Chamberlin argues that monopolistic
competition need not bring higher profits to the marginal firm in a given industry. Instead it may
allow the existence of a larger number of firms making normal profits.