Modern Economic Theory

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Modern Economic Theory

Product differentiation

 In sharp contrast to perfect competition, where there is only one homogeneous commodity, in monopolistic competition there is differentiation 01″ products, “Products arc not homogeneous, as in perfect competition, but neither are they only remote substitutes as in monopoly. What this really means i~ that in monopolistic competition there arc various ‘monopolists’ competing with one another. These competing monopolists do not produce identical goods. Neither do they produce goods which arc completely different. Product differentiation means that products are different in some ways, but not altogether

Many examples of monopolistic competition and product differentiation can be cited. Many firms in India produce toothpaste, but the product of each differs from its rivals in one or more respects. Different toothpastes like Colgate, Binaca. ‘Forhan, Colin , McClean, and soaps Lux, Sunlight. etc., provide examples of monopolistic competition. Other exam pies of monopolistic companion arc those of the producers of soap (Lux, Rexona, Breeze, Hamam, Sunlight, etc.). toothbrush (Colgate, Dr. West’s, Wisdom, etc.), retailers shops, barber shops, etc. ‘Real’ or physical differences, like those of materials used, design and workmanship, are no doubt important means of product differentiation. But “imaginary” differences created through advertising, packing and the use of trade marks and brand names arc the more important methods by which products arc differentiated, even if physically they arc identical or almost so. Finally, the conditions of sale ,II”, help ill the differentiation of the products. For

the location of a shop, the courteousness IIr those who serve at the counters, etc., makes for the differentiation of products. Many. Under monopolistic competition, there are many firms, but it must not be assumed that it requires hundreds or thousands of firms. It requires only a fairly large number -say 25, JO, 60 or 70. Many important conclusions follow from the existence of a fairly large number of firms: First, an individual firm has relatively small part of the total market so that each has a very limited control over the price of the product. Again, thc presence of relatively large number of firms ensures that collusion by them to restrict output to raise price is most unlikely. Finally, with a large number of firms in the industry. there is no feeling of mutual inter-dependence that each firm determines its price-output policies without considering the possible reactions of rival firms.

In other words, a monopolistically competitive firm follows an independent price pupils. And this is a very reasonable way to act in a market where one’s rivals arc numerous. If a firm lowers its pI ice, its gain in sales will he spread thinly over many of its rivals so that the extent to which each of the rival firms suffers will be negligible. Hence, these rivals will have no reason to retaliate. As in perfect competition, in the monopolistic competition too, in the long-run, there is freedom of entry and exit. That is, in this case, there arc no barriers to entry as fl-UI.J under monopoly. As explained above, where there is monopolistic competition, the commodity bought am) sold is not a standardized commodity but a differentiated product, ) Since, competition is no longer exclusively on the price basis. Buyers are now buying a combination of cation ••1store, packing. trade mark. personality of people. and so on). TIle buyers are willing!! III pay fl’l their favourite product something nun c than the milk price of a standardised product. This will depend on the estimate in their own minds a~ to the ~lIpnlllrity of their favourite product. regardless (If its imnu sic worth, or what the seller claims it to be. Because of consumer’s attachment to a purucu lar brand. the seller acquires a monopolistic inffucnrc on his market. If he raises his price a little, he may lose many (If his customers. but not all of them. Similarly. a reduction in price may bring him Cadditional customers but not many. Thus. thc demand curve facing a firm under monopolistic competition is a downward sloping curve. i.c., ifhe wants to sell more. the seller has to lower his price. This is unlike the demand curve in perfect competition. where for any individual seller. the curve is absolutely clastic at the ruling price (i.e.• it is a horizontal straight line parallel to the X-axis). He cannot influence the market price hut he can sell anv amount at the prevailing price. without having any fear of depressing it. But. under monopolistic competition this is not so. The seller has some amount of monopolistic control over his brand but his control is tempered by thc rcalisation thut thcrc arc dose substitutes (similar though not exactly identical products) available in the market. Hence.too high a price will mean his customers shifting to the rival brand. Thus. unlike as in perfect competition but as in monopoly. the demand curve (or the average revenue curve) for a firm under monopolistic competition is a downward sloping curve. But unlike monopoly. where there arc no close substitutes available for the monopolised commodity, the demand or average revenue curve under imperfect competition is fairly elastic. because of the presence of close substitutes.

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