Monopolistic Competition

Monopolistic competition is a type of market structure in which there is a significant number of

firms—perhaps 20, 50, or more—that produce similar but differentiated products. It is relatively
easy for firms to enter or exit monopolistically competitive industries due to low barriers to entry. In
monopolistically competitive industries, the economic rivalry among competing firms is often
intense. Table 5.5 shows several industries that operate under conditions of monopolistic
competition. Note that a significant portion of the industry's output is produced by the top 20 or 50
firms in the industry.[1] Still, compared to oligopolies and monopolies, these concentration ratios—
typically measured by the percentage of the industry's output produced by the top four firms in the
industry— are considered relatively low.

Product differentiation is important to firms operating under conditions of monopolistic

competition. Often firms use nonprice competition to distinguish their product from other similar
products. One way to do this is to create brand loyalty through advertising. A second way to
distinguish between competing products is to improve the product's quality, thereby building a
positive business reputation. A third way to distinguish one product from another is by offering
related services such as a knowledgeable sales staff or free service calls to customers. Finally, firms
might offer conveniences such as a “no questions asked”

Table 5.5 Concentration Ratios for Selected Monopolistically Competitive Industries

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Percentage of Industry Output by Number of Firms

Industry Top 4 Top 8 Top 20 Top 50

Manufacturing Auto parts 19 28 42 56

Furniture 21 27 37 49

Retail

Convenience stores

16 20 23 26

Hardware stores 20 23 27 30

Limited-service restaurants 8 11 17 21

Source : U.S. Bureau of the Census/American FactFinder, “Concentration Ratios: Share of Shipments
Accounted for by the 4, 8, 20, and 50 Largest Companies for Industries: 2007,” 2007 Economic
Census

return policy or conveniently situated stores, factory outlets, or service centers. Product
differentiation gives these firms some market power and thus, some control over the product's
price.
The traditional textbook model states that monopolistically competitive firms earn zero economic
profits in the long run mainly because competitors are free to enter this type of industry and drive
prices down. Yet this model assumes that these firms produce the same tired products with the
same production methods as in the past. Firms in monopolistically competitive industries can
innovate, however, and reinvent themselves by developing new and better products, expanding
product lines, and lowering production costs. Consider recent innovations made by profitable
limited-service restaurants such as health-conscious menu items, drive-through windows, and
delivery services. Through innovation, monopolistically competitive firms can maintain healthy
profits for a very long time.