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Part III: Market Structures and the Decision-Making Environment
Competing with Rivals All Around You in Monopolistic Competition Although competitive behavior in oligopolies leads to mutual interdependence, monopolistically competitive markets are closer in similarity to perfectly competitive markets (see Chapter 9). Monopolistically competitive firms and perfectly competitive firms do, however, have one crucial difference. Although monopolistically competitive firms produce a standardized type of commodity, some differentiation exists among the goods produced by different firms. As a result, monopolistically competitive firms produce goods that are used in similar ways (standardized type of commodity), while some small difference, such as flavor, color, and/or branding, exists. On the other hand, perfectly competitive firms produce goods with no differentiation.
Product differentiation gives firms some degree of monopoly power so they can establish the good’s price. On the other hand, perfect standardization, such as exists in prefect competition, results in the firm having no influence on price. Perfectly competitive firms are price takers. Pizza is an example of a monopolistically competitive market. You know what a pizza is, and it is essentially the same type of product at any restaurant — it’s a standardized type of product. But not all pizzas are identical; hence, you probably have a favorite. The differences that lead to you having a favorite pizza represent differentiation, and as a result, firms in monopolistically competitive markets are able to set the price they receive for their good. You’re willing to pay a little more for your favorite pizza.
Characterizing Monopolistic Competition The three major characteristics of monopolistically competitive markets are: ✓ Large number of firms: Because an individual firm is one out of a large number of firms, it provides a fairly small percentage of the good available in the market. Therefore, the individual firm has limited influence on the commodity’s price. In addition, because of the large number of firms, monopolistically competitive firms don’t regard themselves as being mutually interdependent and don’t take into account how rivals respond to their actions. Finally, the large number of firms prevents collusive behavior in monopolistically competition. ✓ Standardized type of commodity with interfirm differentiation: Monopolistically competitive firms produce a standardized type of commodity with slight differentiation among firms. Several factors account
