What is the difference between perfectly competitive market and monopolistic competitive market?

Read this chapter to learn about monopolistic competition. Make sure to distinguish the short-run from the long-run model.

The key difference between perfectly competitive markets and monopolistically competitive ones is efficiency.

Learning Objectives

Differentiate between monopolistic competition and perfect competition

Key Takeaways

Key Points

• Perfectly competitive markets have no barriers of entry or exit. Monopolistically competitive markets have a few barriers of entry and exit.
• The two markets are similar in terms of elasticity of demand, a firm's ability to make profits in the long-run, and how to determine a firm's profit maximizing quantity condition.
• In a perfectly competitive market, all goods are substitutes. In a monopolistically competitive market, there is a high degree of product differentiation.
  

Key Terms

• perfect competition: A type of market with many consumers and producers, all of whom are price takers
  

Perfect competition and monopolistic competition are two types of economic markets.

Similarities

One of the key similarities that perfectly competitive and monopolistically competitive markets share is elasticity of demand in the long-run. In both circumstances, the consumers are sensitive to price; if price goes up, demand for that product decreases. The two only differ in degree. Firm's individual demand curves in perfectly competitive markets are perfectly elastic, which means that an incremental increase in price will cause demand for a product to vanish). Demand curves in monopolistic competition are not perfectly elastic: due to the market power that firms have, they are able to raise prices without losing all of their customers.

Demand curve in a perfectly competitive market: This is the demand curve in a perfectly competitive market. Note how any increase in price would wipe out demand.Also, in both sets of circumstances the suppliers cannot make a profit in the long-run. Ultimately, firms in both markets will only be able to break even by selling their goods and services.Both markets are composed of firms seeking to maximize their profits. In both of these markets, profit maximization occurs when a firm produces goods to such a level so that its marginal costs of production equals its marginal revenues.

Differences

One key difference between these two set of economic circumstances is efficiency. A perfectly competitive market is perfectly efficient. This means that the price is Pareto optimal, which means that any shift in the price would benefit one party at the expense of the other. The overall economic surplus, which is the sum of the producer and consumer surpluses, is maximized. The suppliers cannot influence the price of the good or service in question; the market dictates the price. The price of the good or service in a perfectly competitive market is equal to the marginal costs of manufacturing that good or service.In a monopolistically competitive market the price is higher than the marginal cost of producing the good or service and the suppliers can influence the price, granting them market power. This decreases the consumer surplus, and by extension the market's economic surplus, and creates deadweight loss.Another key difference between the two is product differentiation. In a perfectly competitive market products are perfect substitutes for each other. But in monopolistically competitive markets the products are highly differentiated. In fact, firms work hard to emphasize the non-price related differences between their products and their competitors'.A final difference involves barriers to entry and exit. Perfectly competitive markets have no barriers to entry and exit; a firm can freely enter or leave an industry based on its perception of the market's profitability. In a monopolistic competitive market there are few barriers to entry and exit, but still more than in a perfectly competitive market.

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Perfect and monopolistic competitions are forms of market structure that determine the level of competitiveness between companies in a specific region.

What is Perfect Competition?

The term perfect competition is used to describe a market scenario where there are a large number of seller and buyers who are selling and buying similar goods and services.

Since the products and services bought or sold in this market scenario, there are no barriers to entry or exit and the prices are almost identical.

It is difficult to have a market with the characteristics that demonstrate a perfect competition, but the scenario is used to help understand other market structures, which include monopolistic or oligopolistic competitions.

What is Monopolistic Competition?

Monopolistic competition is used to explain a scenario where there are a large number of buyers of a specific product but a very few number of sellers of the same product.

A dominant seller controls prices, quality, and quantity of products or services in monopolistic competition.

Price Determination for Perfect and Monopolistic Competition

In perfect competition, the forces of demand and supply determine the prices of goods and services. This means that all the firms in that market sell the products at that price.

The prices of goods and services in a monopolistic competition are determined by the enterprises in that market. Each company sells products at its prices.

However, the dominant company in a monopolistic competition has a ripple effect whereby it can determine the prices of goods and services in that market.

Product Standardization in Perfect and Monopolistic Competition

Product and service standardization characterize perfect competition. This means that all the products in that market have similar characteristics and are produced using the same technology.

On the other hand, goods and services offered in the monopolistic competition are not standardized. The products and services provided do not have similar features and are not produced using the same technology.

Consumers use the different features of the products and services to determine which goods to purchase owing to taste and preferences.

Number of Sellers and Buyers in Perfect and Monopolistic Competition

A large number of sellers producing similar goods and services characterize the market structure in perfect competition. Additionally, perfect competition has a large number of buyers buying the products produced by the companies.

Numerous sellers who sell close substitute goods and services to the buyers characterize a monopolistic competition. A dominant producer dominates regarding products produced and price determination in monopolistic competition.

Selling Costs of Perfect and Monopolistic Competition

In monopolistic competition, all the companies in the market structure produce different products and services, which mean that each firm bears the costs of selling and marketing the products. Each group has to advertise its distinct products or services.

Perfect competition is characterized by similar goods and services, which are sold at uniform prices. Moreover, the selling costs are less because the firms in the industry share the costs of advertising the goods and services on offer.

Average Revenue and Marginal Revenue for Perfect  and Monopolistic Competition

Average revenue (AR) and marginal revenue (MR) are equal in perfect competition. This means that, when the curves are plotted on a graph, the average revenue curve coincides with the marginal revenue curve.

AR = MR

In monopolistic scenario, the average revenue (AR) is higher than the marginal revenue (MR) in a monopolistic competition because any firm willing to increase its sales must lower down the prices of its goods and services.

AR > MR

Slope of Demand Curve

The slope of the demand curve in perfect competition is horizontal, which shows perfect elastic demand. This means that a little change in prices of goods and services leads to an infinite change in the number of products or services demanded.

The slope of the demand curve in a monopolistic show a downward trajectory, which is a representation of elastic demand. This means that changes in prices lead to relatively significant changes in quantity.

Barriers to Entry and Exit

Any company willing to enter and exit a perfect competition can do so with without difficulties. This is the reason why a perfect competition has many businesses leaving and joining in a market characterized by perfect competitions.

The entry and exit in monopolistic competition is a difficult task. New companies fear to enter such markets because there is an already existing dominant enterprise. Additionally, dominating corporations find it difficult to leave such markets because of the profits they are enjoying.

Difference Between Perfect Competition and Monopolistic Competition: Comparison Table

Summary of Perfect Competition vs.  Monopolistic Competition

• Perfect and monopolistic competitions are market scenarios that describe the level of competition in a specific geographical region.
• Perfect competition describes a market structure where many sellers are selling similar goods and services and many buyers buying related products and services.
• Numerous sellers selling goods and services to buyers characterize a monopolistic competition. However, a dominant seller is controlling the market regarding prices and quality of products.
• Other differences between perfect and monopolistic competition include the barriers to entry and exit, the slope of the demand curve, average revenue and marginal revenue, product standardization, and price determination among others.

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