Monopolistic competition, is a market structure where firms have many competitors but each firm sells a slightly different products, but are essentially competing for the same customers. Edward Chamberlin, an American Economist developed the theory of monopolistic competition because he was unsatisfied with the two theories that existed at the time between monopoly and perfect competition and so he wanted to create a balance between the two existing theories.
Edward Chamberlin made a set of assumptions that he assumed to be necessary for this market structure to perform properly.
1. There is freedom to leave or enter the industry which means that there is no barriers to exist or entry. Since most firms are in a state of monopolistic competition, the amount of investment is large since there is an amount of money used for making products look different and advertising. With the no barriers to exist or entry, firms will leave a market if firms are losing money and firms will enter a market where firms are earning profit.
2. A Large number of firms in the market.
3. Firms produce differentiated products. Product differentiation is the ability of a firm to make their products look different from similar products in the market.
There are four main types of product differentiation:
a) Physical product differentiation: here, firms use shape, size colour, design, performance and features to make their product look different.
b) Marketing differentiation: firms try to differentiate their products through unique packaging and promotional techniques.
c) Human capital differentiation: firm ensure to create differences in the quality of their services, through the skills of their employees, appearance (unique uniform) and many other ways.
d) Differentiation through deliveries: this includes deliveries.
Most of the products that firms sell are close substitutes which means that consumers can easily switch to other options if the product they usually buy has become expensive and cannot afford to purchase it anymore. So to avoid this, firms use advertising (marketing differentiation) to let their customers know why they are superior over the product that the consumer would want to switch their option to. However as the firms advertise their products, there will be some extent of brand loyalty to the product even though prices go up even by a little