Neither perfect competition nor monopoly truly represents the real market situations. Hence, the conclusions derived from these hypothetical or unrealistic market forms can hardly apply to the behaviour of business firms in the actual world.
These two theories constituted the classical micro economic theory from Marshall to Knight. Attempts were made to bridge the gap between these extreme forms of market structure by E.H. Chamberlin and Joan Robinson. They worked independently and brought out ‘Theory of Monopolistic Competition’ and ‘Economics of Imperfect Competition’ respectively.
These theories implied that perfect competition and pure monopoly are two opposite limiting cases between which a series of intermediate cases lie, differing in relative strengths of monopolistic and competitive elements. It is important to note that Piero Sraffa, a Cambridge economist did the path breaking work by being the first to point out the limitations of competition or monopoly analysis.
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He was followed by Harold Hotelling and F.Zenthen. However, they could not think of an alternative form of market structure. Chamberlin and Robinson received greater attention, who followed Sraffa’s line and arrived at the same solution for the firm and market equilibrium, though differing substantially in their analytical approach and methodology.
Monopolistic competition refers to a market structure in which there are many sellers selling similar but differentiated products and there is existence of free entry and free exit of firms. In other words, it is a situation, where there is a keen, but, not perfect competition among sellers producing close, but not perfect substitutes.
Consumer goods like tooth pastes, brushes, bathing soaps, detergents, textiles, television sets, refrigerators automobiles, etc. fall under the category of monopolistic competition in the Indian market.
Here, each firm is a monopolist of its own differentiated product. But, the products supplied by the firms are close substitutes of each other. Hence, price and output decisions of a firm depend upon the policies of the rivals only to some extent.