What is the difference between perfect competition and monopolistic competition

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Monopoly differs from perfect competition in the following ways :(i) In monopoly, there is a single seller (or firms) of a product whereas under perfect competition there arelarge number of sellers (or firms). (ii) A monopolist produces or sells a product which has no close substitute. On the other hand, under perfect competition, the products sold by the various firms are homogenous or identical. They are perfect substitutes of each other.(iii) In case of monopoly, there is no freedom of entry of new firms in the industry whereas under perfect competition, there is free entry and exit of firms in the industry. (iv) For a monopolist firm, the demand curve of its product slopes downward to the right. On the other hand, a perfectly competitive firm faces a perfectly elastic downward curve (i.e., horizontal straight line).
There are many similarities between monopolistic competition and perfect competition:(i) A large number of buyers and sellers: There is a large number of buyers and sellers in both markets. This limits their influence on market price. Neither the individual seller nor buyer can. influence the market price. The share of each seller and buyer in the market is very small. Each seller supplies a small portion of the market demand. (ii) Freedom of entry and exit of firms: There is freedom of entry and exit of firms in both markets. This ensures that there are neither abnormal profits nor any losses to a firm in the long run. If firms are making profits, new firms are attracted to enter and raise the total supply of the industry. This reduces market price and wipes out profits. In case the firms are incurring losses, the existing firms leave the industry and this reduces the total supply. This raises the price till all losses are wiped out. (adsbygoogle = window.adsbygoogle || []).push({}); The dissimilarity between monopolistic competition and perfect competition is that under perfect competition, all sellers are assumed to be producing homogeneous products and as a result, the firm cannot influence the market price. On the other hand, under monopolistic competition, firms are assumed to be producing differentiated products and consequently, the firm enjoys more monopoly of his product and influence the market price.
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Solution

Monopoly differs from perfect competition in the following ways :(i) In monopoly, there is a single seller (or firms) of a product whereas under perfect competition there arelarge number of sellers (or firms). (ii) A monopolist produces or sells a product which has no close substitute. On the other hand, under perfect competition, the products sold by the various firms are homogenous or identical. They are perfect substitutes of each other.(iii) In case of monopoly, there is no freedom of entry of new firms in the industry whereas under perfect competition, there is free entry and exit of firms in the industry. (iv) For a monopolist firm, the demand curve of its product slopes downward to the right. On the other hand, a perfectly competitive firm faces a perfectly elastic downward curve (i.e., horizontal straight line).

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In this article we will discuss about the similarities and dissimilarities between Perfect Competition and Monopolistic Competition.

Similarities between Perfect Competition and Monopolistic Competition:

The two market situations have the following points of similarities:

(1) The number of firms is large both under perfect competition and monopolistic competition.

(2) In both, firms compete with each other.

(3) In both, there is freedom of entry or exit of firms.

(4) In both, the equilibrium is established at the point of equality of marginal cost and marginal revenue.

(5) In both the market situations, firms can earn super-normal profits or incur losses in the short-run. But in the long-run, firms earn only normal profit.

Dissimilarities between Perfect Competition and Monopolistic Competition:

There are, however, certain points of dissimilarities between perfect competition and monopolistic competition.

Which are discussed as under:

(1) Under perfect competition, each firm produces and sells a homogeneous product so that no buyer has any preference for the product of any individual seller over others. On the other hand, there is product differentiation under monopolistic competition. Products are similar but not identical. They are close substitutes. They differ from each other in design, colour, flavour, packing, etc.

(2) Price, under perfect competition, is determined by the forces of demand and supply for the entire industry. Every firm has to sell its product at that price. It cannot influence price by its single action. It has to adjust its output to that price.

Thus every firm is a price-taker and quantity-adjuster. On the other hand, every firm has its own price-policy under monopolistic competition. It cannot control more than a small portion of the total output of a product in a group.

(3) Geometrically, the demand curve (AR) of a firm is perfectly elastic under perfect competition and the marginal revenue (MR) curve coincides with it. As against this, the demand curve of a firm is elastic and downward sloping under monopolistic competition and its corresponding MR curve lies below it.

It implies that a firm will have to reduce the price of its product to increase its sales by attracting some customers of its competitors, provided the latter do not reduce their prices.

(4) Though the equilibrium conditions of the two market situations are the same, yet there are differences in the price-marginal cost relationship between the two. When under perfect competition MC=MR, price also equals them since price (AR)=MR.

This is because the AR curve is horizontal to the X-axis. Since the AR curve slopes downward to the left, the MR curve is below it under monopolistic competition. So, price (AR)> MR=MC.

(5) Another difference between the two market situations relates to their size. In the long-run, competitive firms are of the optimum size and produce to their full capacity because price (AR)=LMC=LAC at its minimum.

But under monopolistic competition, the firms are of less than the optimum size and possess excess capacity because the AR curve is downward sloping and cannot be tangent to the LAC curve at its minimum point. The firm’s equilibrium condition is Price (AR)=LAC>LMC=MR.

(6) Another difference between perfect competition and monopolistic competition relates to selling costs. There is no selling problem under perfect competition where the product is homogeneous, and hence, no selling costs.

The firm can sell at the ruling market price any quantity of its product. But under monopolistic competition where the product is differentiated, selling costs are essential to push up the sales. They are incurred to persuade a buyer to purchase one product in preference to another.

(7) The last difference between the two market situations is that the output of the firm under monopolistic competition is smaller and price higher than under perfect competition. This is illustrated in Figure 6 where d and MR are the average and marginal revenue curves of the firm under monopolistic competition, and AR=MR of the competitive firm.

The LMC and LAC curves are assumed to be the same for both the firms.

The equilibrium of the competitive firm is established at E and that of the monopolistic competitive firm at E1. The firm under monopolistic competition sells OQ1 output which is less than that of the competitive firm’s output OQ while its price Q1A1 is higher than the price QE of the competitive firm.