Chamberlin’s concept of monopolistic competition is a blending of competition and monopoly. The distinguishing feature of monopolisitc competition which makes it as a blending competition and monopoly is the differentiation of the product.
This means that the products of various firms are not homogeneous but different though they are closely related to each other. When there is any degree of differentiation of products, monopoly element enters into the situation.
When there are a number of firms producing differentiated products each one has a monopoly of its own product, but is subject to the competition of close substitutes. Since each is a monopolist and yet had competitors, we have a market situation which can be aptly described as monopolistic competition.
Monopolistic competition prevails in retailing, in the service industries and in some branches of manufacturing.
A firm under monopolistic competition has to face various problems which are absent under pure competition. Since the market of the individual firm under pure competition is completely merged with the general one, it can sell any amount of the goods at the prevailing market price.
But under monopolistic competition, individual firm’s market is isolated to a certain degree from those of its rivals with the result that its sales are limited and depend upon (1) its price, (2) the nature of the product, and (3) the advertising outlay that it makes.
In seeking to obtain maximum profits, the firm under monopolistic competition can review its price policy or it can review its policy on the quality of its products or it can review its policy on advertisement. Thus the firm under monopolistic competition has to face more complicated problems than a purely competitive firm.
Equilibrium of an individual firm under monopolistic competition involves equilibrium in three respects—in regard to the price, the nature of the product and the amount of advertising outlay that it should make. We shall discuss the three kinds of adjustments.