Economic theory
advocates competition for social welfare. As the completive intensity
increases, there is an increasing rush to reduce prices. Firms reduce price
till such a point of time wherein their marginal costs are equated to the
prices. In a perfect competition, the firms have control over the output but
have no control on the price. They are price takers, in other words, prices are
determined by the market. This is so because of the homogeneity of the product
thus negating the possibility of differentiation. Furthermore, in perfectly
competitive world, the barriers of entry are nil. If there arises the existence
of supernormal profit, other prospective suppliers are attracted by this
possibility thus planning their entry into the market. As new players enter
into the market, the output increases. Implied is an increase in the goods
being offered for sale relative to the demand for goods. The imbalances thus
created in supply and demand make firms reduce price which will proceed till
such time the supernormal profits are wiped out. There exists only the normal
profits which are achieved wherein the price is equal to the marginal cost of
the firm.
Yet, firms,
desire a differentiation to have some control on the price. The emergence of differentiation
results in the rise of monopolistic competition. In the monopolistic
competition, while the barriers of entry are low, the goods are close substitute
for another, firms go at great lengths to convince the buyers that they are
unique products and not substitutes of others. They argue that they are
different in many respects perhaps from quality to quantity to packaging to the
positioning to what not. The entire discipline of marketing and advertising
exists in pursuit of differentiation to project their offerings unique thus
seeking control over the price. These differentiating barriers might be
permanent or transient. The control over the price is often transient. Despite the
best efforts to differentiate, the consumers do perceive them as substitutes. These
are something what we observe from the toothpaste market to soap market to
market for consumer durables, home appliances, and electronics to many other
aspects of real life. Monopolistic competition pervades real life yet super
normal profits are thin in many dimensions. Firms like Coke or Pepsi have
perhaps narrowed down the number of players at a global level. Maybe in the
toothpaste market or soap market, the number of players too have narrowed down
though not in the same extent as soft drinks. Yet what makes these as
monopolistic competition is the fact the barriers of entry are technically
open. The barriers to entry have hardly anything to do with the production side
but have to do with the advertising part. The sheer expanse of advertising which
some of the players have undertaken have resulted in very few players operating
in the market. There are number of minor players operating in the market, yet
these players individually have low market shares barely sufficient to register
their presence leave affecting the prices. To many firms, the prices are set by
larger players with smaller players having to go along with the prices. Those
with deeper pockets will sustain longer thus the number of players reduce
further in many ways impacting consumer welfare, choice and diversity.
However, most of
these goods in monopolistic competition are priced low. This is because of the competitive
intensity among the various players and low switching costs. One of the barriers
that does not get strengthened in monopolistic competition is the switching
cost. Higher prices for Pepsi might induce a consumer to try Coke and other
alternatives and vice versa. Higher prices for Nescafe might make a consumer
look for alternative choices in the mid to long run. Higher prices for Close Up
would interest the prospective buyer to evaluate Colgate or Pepsodent and vice
versa. Therefore the possibility of prisoner’s dilemma or rather the prisoner’s
dilemma itself will keep the prices low. The switching costs thus are very easy
and go some way in keeping prices low. Each company will create a loyal base
around which it can play on prices but that would be to a limiting length. The dynamics
of own price elasticity of demand, the consumer surplus, low switching costs,
the substitutes creating a cross price elasticity
all go in making the prices lower.
Monopolistic
competition revolves around brands tools for differentiations. It is the
consumers who associate the good with the brand. The more the visible the
brand, the better market power it is likely to command. Yet, brands too are
transient. Brands constantly slide from their perch. It is more akin to the
snakes and ladders game. Therefore, the differentiation notwithstanding, the
control on prices remain low. They seek to build a loyalty, yet barring few
most do not command a strong sense of loyalty that will make consumers stick on
irrespective of change in prices. There might be cult brands who do command
pricing power, but their presence and pricing power has taken far more than a
simple positioning differential to achieve that. Yet, every firm seeks to
create a market share and command a larger share for itself. The advertising,
branding and other promotional means command high fixed costs and therefore,
their costs are recovered only when these costs are apportioned larger levels
of output. Implied is a scale of different kind in leveraging benefits from
advertising and promotional measures. These are demand side economies. The economies
of advertising and branding are converting monopolistic competition to
oligopolistic and duopolistic competition.
In the economic
analysis, the supply side production economies result in high fixed costs being
apportioned over larger output in volume or diversity. These create conditions
for economies of scale and scope thus erecting barriers of entry, a movement
from competition to oligopoly to monopoly or at times duopoly. Yet, in the
analysis of monopolistic competition, while economies of scale and scope do
play a role, the transformation to oligopolistic or duopolistic competition is
on account of demand side economies. Economies of scope too arise to reap the
advertising and promotional and branding economies by playing on product and
brand extensions. It is no surprise that many of the firms in the fast moving
consumer goods or food and beverages sector do offer multiple products under a
single umbrella to consolidate their position. Therefore, the barriers of entry
are sought to be erected on the demand side. Yet their inability to erect high
switching costs equally accompanied by a failure to sustain cartels or price
collaborations make these monopolistic competition while possessing features of
duopoly or oligopoly yet unable to breach or break out of the price wars.
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