Chapter 15, Problem dWYWL

To determine

How does monopolistic competition pose a tradeoff between lower prices and greater product diversity?

Concept Introduction:

Monopolistic Competition An imperfect market competition with a large number of sellers selling differentiated product is called the monopolistic competition. It exhibits the elements of both a monopoly and perfect competition. The defining characteristics of the market are- It has a large number of firms, relative free entry and exit of firms, product differentiation, imperfect information, transportation costs, inelastic demand and inefficient production.

Product Differentiation - The product differentiation can be physical or psychological. Physical differentiation implies difference in packing, size, shape etc of near identical products. This can further be categorized into horizontal or vertical differentiation. The former refers to the situation where the consumers base their decisions on subjective preferences while the latter refers to one where products differ by quantitative or qualitative factors like technical properties, level of technological sophistication.

Psychological differentiation is a marketing process wherein the seller makes the customers believe that his product is unique and superior to that of his competitors. This creates a sense of value for the product of the seller and their sales and profits increase.