Though monopolistic competition retains some of the assumptions of perfect competition, yet it differs from extreme and ideal model of perfect competition on many grounds.
1. Product Differentiation:
Under perfect competition, all the firms in the industry produce a homogeneous product. There is no variety of products, as the products produced by different firms are perfect substitutes to each other.
Therefore, the demand curve facing a firm is perfectly elastic and is shown by a horizontal line at the equilibrium market price.
The corresponding total revenue (TR) curve under this market form is a positively sloped straight line through the origin. The average revenue (AR) curve (which is equal to price) coincides with the horizontal demand curve and hence the marginal revenue (MR) curve. Here, the cross elasticity of demand among the products is infinite.
On the other hand, the monopolistic firm by practising product differentiation has some degree of monopoly power in influencing the price. These differentiated products satisfy diverse range of human wants.
The demand or the average revenue curve is not infinitely elastic, but, is a highly elastic, downward sloping curve. Further, marginal revenue (MR) curve is also downward sloping, steeper than the average revenue curve. The cross elasticity of demand among the products is very small.
2. Selling and Transportation Cost:
Under perfect competition, on account of perfect knowledge on the part of buyers and sellers, selling cost or advertising does not exist. Thus, there is no non-price competition here. Further, there is no transportation cost here. Here, there is no scope for innovation and research due to homogenous nature of product.
On the contrary, monopolistic competition makes it necessary for all the firms to advertise their products to sustain in the business. Here, advertising is the most important form of non-price competition. It can also make consumers better informed about the products, who have not perfect knowledge about the products. Furthermore, there are cross transportation costs under monopolistic competition. Here, the firm’s remain busy in new discoveries and innovations to improve the quality of the product.
3. Concept of Industry:
Concept of industry applies well under perfect competition, where firms produce homogeneous products. Every firm in the industry is just a price taker and quantity adjuster. It can sell any quantity of the product at the given price determined by the industry.
On the contrast, since the products are heterogeneous under monopolistic competition, Chamberlin redefines the concept of industry and calls it the ‘product group’, i.e., a group of firms producing differentiated products. A firm under the group has to take decisions on three policy variables, namely, price of the product, quality of the product and selling cost.
The short-run equilibrium conditions for the equilibrium of the firm are same under both perfect competition and monopolistic competition, i.e., MR=MC and slope of MC < slope of MR. Further, under both market forms, price is equal to average cost in the long-run. However, under perfect competition, price is also equal to marginal cost. While, it is greater than marginal cost under monopolistic competition. In other words Price = Minimum LAC.
If equilibrium prices and outputs are compared, we observe that equilibrium price is lower under perfect competition than that under monopolistic competition (OPC < OPM in Fig. 15.9).
Furthermore, equilibrium output is greater under perfect competition than that under monopolistic competition (OQC> OQM in Fig. 15.9). Here, Price > Minimum LAC
5. Excess Capacity:
Under perfect competition, the industry does not have any excess capacity, since each firm produces at the minimum point of long-run average cost (LAC) curve. There is optimal allocation of resources, as price is equal to marginal cost.
Since, the firms produce efficient output, this is ideal output from the social point of view and there is no social waste or dead weight loss. Here, the economic welfare is maximised. The consumers get enormous amount of consumer surplus.
On the contrary, for a firm operating under monopolistic competition, long-run equilibrium point is necessarily to the left of the minimum point on the LAC curve. This means that excess capacity is inevitable under monopolistic competition.
Thus, a monopolistically competitive firm always produces socially sub-optimal output, i.e., P>MC. Even Chamberlin who defines excess capacity different from Joan Robinson agrees that excess capacity exists under monopolistic competition on account of non-price competition.
The monopoly element does not allow production to expand to the socially desired level resulting in welfare loss (dead weight loss similar to the case of monopoly, as discussed in the previous chapter on Pricing under Monopoly under heading ‘Resource Allocation and Welfare’. The consumer get little amount of consumer surplus. The unprecedented waste and misuse of the resources minimises the economic welfare.