Monopolistic Competition

Monopolistic competition, first analysed systematically by Edward Chamberlin, describes a market that mixes features of both perfect competition and monopoly. Its main features are: a fairly large number of sellers (large enough that no single firm's decisions visibly affect its rivals); a differentiated product — rival firms sell close substitutes, distinguished by brand name, packaging, quality, after-sales service or location rather than being physically identical; free entry and exit in the long run; and heavy reliance on selling costs (advertising, packaging, sales promotion) in addition to production costs, because product differentiation itself must be actively created and maintained.

Because products are close-but-imperfect substitutes, each firm faces a downward-sloping demand curve — unlike the horizontal curve under perfect competition — but the curve is comparatively flat (highly elastic), since many similar substitutes are available. A firm still equates $MC = MR$ to fix its profit-maximising output and price. …