Definition

Monopolistic competition is a type of market structure characterized by a large number of firms or producers competing to produce a great variety of similar products that they constantly try to differentiate. 

In monopolistic competition there are many different producers manufacturing similar products. This generates many substitutes of each product or commodity on the market. Although there are several options available for the consumer, these options are not identical to each other.

In a monopolistic market structure, the goods produced differ from each on the grounds of product differentiation and each producer is recognized by its own brand name.

Product Differentiation

Product differentiation can be defined in terms of the following characteristics:

1. Quality
2. Ingredients
3. Packaging or Presentation
4. Service
5. Warranty
6. Marketing or Promotion
7. Shape
8. Size
9. Taste etc.

Example:

The industry of garments is a perfect example of monopolistic competition. You may find the same type of clothing in different stores, but they are not really the same with regards to their different characteristics of fabric quality, stitching, etc.

Characteristics

Monopolistic Competition comprises several characteristics. The presence of the following characteristics in a market structure shall indicate that monopolistic competition exists in the market:

1. There is a large number of producers of the same type of product in the market;
2. Commodities being produced differ from each other only on the basis of product differentiation;
3. There is free entry for new firms and easy exit for existing firms, unlike market characterized by monopoly;
4. The demand curve for monopolistic competition is flatter or elastic, which implies that small changes in prices will have a significant impact on the demand of the specific product;
5. Advertisement costs are high. Large amounts of money are being spent by producers for the purpose of marketing their products.

Output decisions

Similar to other types of market structure, the output decisions in the case of monopolistic competition depend on the period of time during which a firm is conducting its operations on the market. Following this perspective, output decisions in the short run differ to those in the long run.

In the short run, the producer will face the following possibilities of profit or loss:

1. Abnormal Profit:When the level of production reaches the point where total revenue is greater than total cost.
2. Normal Profit:It is the state where the total revenue and total cost are equal.
3. Loss:It is the state where total revenue is less than total cost.
4. Shut Down Decision:It is the case when production costs far outweigh the revenues so the producer decides to shut down his business.

In the long run, in monopolistic competition the producers always earn Normal Profit.