Marshall’s perfect competition was an illusion. Mrs. Robinson’s imperfect competition and monopoly were also away from reality. Pure monopoly is a myth. Seller can claim monopoly only and only if he has command over buyer’s choice. No seller can have such a control because buyers have an alternative to buying. Not buying. So long as that option exists, monopoly remains a myth. In mid 1930s, Prof. Chamberlin developed his theory of monopolistic competition. He pointed out the Marshall’s assumption of large number was not the reason that made a seller a ‘price taker’. In practice there may be a reasonably large number of sellers in a market. They become price makers because they have an identity that they create and preserve. Chamberlin dropped the assumption of homogeneity of product and perfect knowledge to develop his theory. Chamberlin defined a ‘product’ in a different way. He said that a ‘product’ is a bundle of satisfaction. Anything that changes the satisfaction of the buyers would change the value of the product. He introduced the concept of ‘product differentiation’ He argued that a large mass of product is differentiated by quality, quantity, size, shape, surrounding under which the product is sold, methods of selling and the like. Even the image of the seller and the locational factors would be a part of product differentiation. In perfect competition, buyers and sellers came together as a matter of chance. Chamberlin argued that in practice buyers and sellers come together as a matter of choice. Product differentiation creates a preference in the minds of the buyers. Buyers’ preference may be real or perceived. So long as buyers’ have a choice and a preference, the seller can create such preference for his product ane to the extent such preference has been created, the seller enjoys a monopoly of sort. How so ever little a seller be, he controls a group of buyers through the preference created in their minds and hold on to them. So far as they are concerned, he is monopolist. Every seller despite the limited monopoly he may enjoy has to compete on three fronts. He has to retain his buyers, he has to compete to get competitors’ buyers and he has to try to get as many of the new buyers as is possible. All markets have such competition monopolist. Chamberlin calls the market structure monopolistic competition. Chamberlin also drops the Marshall’s assumption of perfect knowledge. With product differentiation, the seller will have to inform the buyers of he is different. The modern day sales promotion, brand building and advertising involve large expenditure. Such selling costs had no place in economics of perfect or imperfect competition. Chamberlin was the first to recognize the need for and power of selling costs.
Individual Pricing under Monopolistic Competition:
Chamberlin argued that for deciding the price and output, MR and MC were not required. By fitting between the AR and AC the area of maximum profits, the seller under monopolistic competition will decide his price at the level where his profits are at a maximum. This is shown in the following diagram.
In the above diagram, PM is the equilibrium price giving rectangle PQRN maximum profits. Any other price – higher or lower would give less than rectangle PQRN profits. PM is essentially monopoly price. Seller has, through product differentiation and selling cost created strong preference in the minds of the buyers giving him maximum profits.
Chamberlin introduces a dynamic concept of group equilibrium. His group is a group of competing monopolists who have established a market presence and identity through product differentiation and selling cost and who compete with each other to retain and enhance their market presence and share. For analytical purpose, he makes the assumption that AR and AC of all sellers in the group are identical. There is product differentiation but based on the...