What do monopoly and monopolistic competition have in common? A similarity between monopoly and monopolistic competition is that in both market structures, firms decide the price level that customers would use to purchase goods and services in the market, but there’s also a significant difference between monopoly and monopolistic competition.
Why is it important? Is there any similarity with perfect competition? Keep reading to learn more!
Introduction
Ideally, the market place should be a space where buyers and sellers freely exchange goods and services. However, for most economies, this is not the case because players have different knowledge, expertise, and access to markets in ways that others do not (Dwivedi 2002). Consequently, it is common to find people or companies competing for different raw materials and access to markets.
Similarly, it is common to find customers haggling sellers for low prices and the latter selling their products at different prices, albeit they may be selling the same goods. These activities often lead to the creation of a perfect, or imperfect, competitive environment for buyers and sellers. Economists use different categories to outline market conditions or market structures that define these situations (Mukherjee, 2002).
Some of the most common categorizations for market differentiation include geographical area, time, and legal framework (Dwivedi 2002). Researchers have used these metrics to categorize markets into different types of perfect or imperfect trading structures (Lipsey & Harbury 1992). Two of the most common ones are a monopoly and monopolistic competition.
Many people have had trouble understanding a monopoly and a monopolistic competition because they sound the same (Rittenberg 2008). This paper strives to highlight the differences between the two types of markets by pointing out the main areas of commonality and differences.
By doing so, we will have a better grasp of the two main types of imperfect markets that exist in many parts of the world – monopolies and monopolistic competition. In the first section of this report, we highlight the similarities between the two types of imperfect market structures, and in the second section of this paper, we highlight the differences between the two. The last section of this paper provides a summary of our findings.
Definition of Monopoly
A monopoly differs from other types of market structures in the sense that there is only one producer in the market (Boyes & Melvin 2012). This situation gives immense power to the firm (monopoly) because it has no competition whatsoever.
More importantly, this producer exercises immense power in determining the price of goods and services in the market, leaving consumers at its mercy. This type of market condition ordinarily has high barriers to entry, thereby locking other players out of it and making those who are daring enough to venture in the same market pay a huge price for their bravery (Mukherjee 2002).
Based on the immense power enjoyed by firms operating in a monopoly market, economists argue that monopolies often have the highest prices in the market because consumers do not have other options to buy their goods or services (Lipsey & Harbury 1992). Monopolists also produce fewer products than other types of firms in other types of markets.
Several reasons explain why monopolies occur. Some of the most common reasons include natural monopolies, huge capital costs associated with market entry, patents associated with certain types of businesses, safely guarded trade secrets, poor access to exclusive or unique assets, location advantages, regulation, and collusion by competitors (Hardy1978).
Economic liberalization policies that have spread throughout most economies have seen the decline of monopolies (Dwivedi 2002). However, a few of them exist. For example, Comcast Corporation in the United States is an example of a monopoly in the present-day market (Rittenberg 2008).
Although some observers dispute this fact, few people could argue with the fact that it enjoys significant monopoly power in some American states and cities, such as Boston, Chicago, and Philadelphia. The company mostly focuses on providing internet, phone, and cable television services. Some people have criticized it for its high prices, but its customers have no alternatives.
Therefore, they have had to remain loyal to the company; otherwise, they would have to forgo the services offered by the company. In other countries, outside the US, monopolies often exist with the support of the government. Furthermore, they are mostly in the utility sector (Suarez-Villa, 2014).
Definition of Monopolistic Competition
Monopolistic competition is often characterized by the presence of many producers in the market (Economics Online Ltd., 2016). The availability of many firms also means that there is product differentiation in the market because each firm tries to outwit the other with unique marketing strategies to encourage customers to buy their goods and leave those of the competitors (Kingston 2012).
Most of the products available in monopolistic competition are close substitutes (Dwivedi 2002). In other words, these types of markets have groups of similar products. Their demand curves are also curved, and firms often refrain from reacting to the market actions of a rival firm because there are multiple players in the market (Cowen & Tabarrok 2012).
Lastly, these types of markets allow for easy entry and exit for firms that are willing to operate in them (Economics Online Ltd. 2016). Most firms that operate in this type of industry are usually similar or symmetric in their operations because they have the same motives for doing business (Kingston 2012). Lastly, it is important to note that marketing is often a key success factor for companies that operate in this market segment.
The US fast-food restaurant industry is an example of a monopolistic competition (Cowen & Tabarrok 2012). A few giant food companies, such as Mc Donald’s and Burger King, dominate the market. Each of these restaurant chains produces differentiated products, such as McDonald’s “Big Mac” and “Happy Meal” (Longley 2013). Burger King also has its unique products, such as the “Frame Grilled Chicken Burger,” and “Chicken Nuggets.”
Although the two restaurant chains may sell the same type of foods, they differentiate themselves based on their pricing and promotion strategies. This is a key characteristic of firms operating in a monopolistic competition.
Similarities between Monopoly and Monopolistic Competition
A large number of Buyers Present in the Market
Both monopolies and monopolistic competitions have a large number of buyers in the market (Mankiw 2011). As mentioned in earlier sections of this paper, the options available to these buyers is the point of difference between these two types of buyers in the market because, in monopolies, buyers do not have many options in the market, while in monopolistic markets, they have relatively more options to purchase goods and services (at least compared to a monopoly). Nonetheless, in both types of markets, there are large numbers of buyers.
Firms decide Prices and Output
In both monopolies and monopolistic competitions, firms decide the price level that customers would use to purchase goods and services in the market. They also decide the level of output of goods and services in the market (Cowen & Tabarrok 2012).
Short-run Equilibrium
Both monopolies and monopolistic markets have the same types of short-term equilibrium curves (Rittenberg 2008). In other words, firms that operate on both types of markets attain equilibrium of their marginal revenues and marginal costs at the same point of output.
The price points set by both companies also depend on the availability of demand for their products and services (Cowen & Tabarrok 2012). However, as highlighted in other sections of this paper, the two types of markets have different long-term outcomes. A graphical representation of this fact will appear in subsequent sections of this paper.
Difference between Monopoly and Monopolistic Competition
Nature of Product
A market monopoly normally avails one homogeneous product in the market (Suarez-Villa 2014). However, a monopolistic market subscribes to the principles of market differentiation, where players avail of different types of products in the market (market differentiation) (FK Publications 2015, p. 359-360).
Different Average and Marginal Revenue Curves
We can also use differences in average revenue curves and marginal revenue curves to explain the differences between a monopoly and a monopolistic market. A monopoly market often has two separate curves for both the average revenue and the marginal revenues of a company. The average revenue denoted by AR represents the price points of different units sold in a monopoly.
Comparatively, the MR index outlines the marginal income reported by firms selling the same units in the same type of market. The downward sloping nature of the units points out that for the firm to sell more units in the monopoly market, it has to lower its price point. The diagram below highlights this type of market dynamic.
The diagram also below shows a comparative analysis of the revenue curves under monopolistic competition.
In the above diagram, we find that the average revenue and marginal revenue curves under the monopolistic competition is still the same as it is in a monopoly.
Although they both slope downwards from left to right, they are more flexible than the ones in a monopoly. This flexibility could be evidenced by the fact that firms operating in the monopolistic competition have a greater output point than those operating in a monopoly (FK Publications 2015).
Implications Regarding Decisions
According to Musgrave and Kacapyr (2009), firms that operate in markets characterized by monopolistic competition, or a monopoly, can adjust their outputs or price points to attract new customers, but not both.
One significant point of departure for firms that operate in the two types of markets is the costs associated with selling because firms in monopolistic competition have to spend a lot of money on advertising costs, while those with a monopoly have to spend little, or no, money on the same because their customers do not have other purchasing options.
Comparison Regarding Profit
When understanding the difference between a monopoly and a monopolistic competition, it is important to appreciate the fact that different firms that operate under any of the above-mentioned market structures may earn normal profits, supernormal profits, or even suffer losses (Serrano & Feldman 2012).
In the short run, firms operating in monopolistic competition may earn supernormal profits or suffer losses, but in the long-run, they are bound to earn normal profits only (Musgrave & Kacapyr (2009).
However, firms that operate in a monopoly are privileged in the sense that they could earn supernormal profits in the long-run. Therefore, in the short-run, both sets of firms could share many similarities, but in the end, these similarities fade away because of market conditions.
Conclusion
This paper has highlighted the points of differences and similarities between monopolistic competition and a monopoly. First, we started by defining the two concepts to have a proper grasp of the different types of market structures defining both markets.
From this review, we found that the main difference between the two types of markets was the number of firms in each market. Monopolies only have one firm in the market, while a monopolistic competition has multiple firms.
Product differentiation also emerged as a key point of difference between monopolies and monopolistic competition because the latter has this attribute, while the former does not. Both market structures share a few similarities in the sense that firms operating in these markets dictate prices and output levels for goods and services and have a large pool of customers.
Of striking significance in our analysis is the realization that the term “monopolistic competition” used to describe this type of market structure comes from the fact that a monopolistic competition shares both the attributes of a perfectly competitive market and a monopoly.
Using this analogy as the main point of comparison between a monopoly and a monopolistic competition, we find that the main differentiating factor in monopolistic competition is its subtle features of perfect competition. In other words, monopolistic competition is a monopoly with a few subtle attributes of a perfectly competitive market.
Broadly, we find that the use of the word “monopoly” in “monopolistic competition” is confusing to most people, but it differs with a “monopoly” because of the multiplicity of firms and the presence of distinguishable products, which are features that are commonly found in perfectly competitive markets.
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