CDS (II) 2021 General Knowledge · Question 70 of 120

Correct — B, Market for soaps. Monopolistic competition has three defining marks: many sellers, a product that each seller differentiates from the others, and free entry and exit. Soap is the textbook case in India — dozens of firms, every bar branded, perfumed and priced a little differently, heavy advertising because differentiation is the whole strategy, and nothing to stop a new brand appearing. Because the products are close but not perfect substitutes, each maker faces a downward-sloping demand curve and has a little pricing power, but free entry keeps long-run profits thin. That combination of many sellers plus differentiation is what the question is testing.

• (a)Retail vegetable markets — A retail vegetable market comes closer to perfect competition — many small sellers, a broadly homogeneous product, buyers who can compare prices at a glance, and almost no branding to differentiate one seller's tomatoes from another's.
• (c)Indian Railways — Indian Railways is the standard Indian example of a monopoly in its own segment: a single supplier of rail transport with entry closed to others, which is the opposite of many sellers.
• (d)Labour market for software engineers — The labour market for software engineers is a factor market in which firms are the buyers and workers the sellers; it is analysed with the tools of wage determination, not with the theory of a product market's structure.

Market structure is classified by how many sellers there are, how alike their products are and how easy entry is. Perfect competition has many sellers, a homogeneous product and free entry, so no seller can influence price. Monopoly has one seller and blocked entry. Oligopoly has a few sellers whose decisions are interdependent. Monopolistic competition sits between perfect competition and monopoly — many sellers, but each with a slightly different product and therefore a little control over its own price.

The trap is the word 'monopolistic', which pulls the eye towards the option that looks like a monopoly, and Indian Railways is placed there for exactly that reason. Read the two words together: monopolistic competition is a form of competition, and the monopolistic part refers only to the small pocket of pricing power that branding gives each seller. The practical test in the examination hall is to ask whether a buyer can tell one seller's product from another's. With soap, obviously yes; with loose vegetables, largely no. The bank records this item under a science heading, which is a stray tag in the source data — the question is plainly microeconomics.

• Monopolistic competition combines many sellers, differentiated products and free entry and exit.
• Each firm in monopolistic competition faces a downward-sloping demand curve and so has limited control over price.
• Perfect competition requires a homogeneous product, so no firm can charge more than the going price.
• Monopoly means a single seller with entry blocked; oligopoly means a few interdependent sellers.
• Advertising and brand-building are characteristic of monopolistic competition, because differentiation is what gives a firm its pricing power.

• Reading 'monopolistic competition' as a near-synonym for monopoly.
• Treating a factor market such as skilled labour as a product-market structure.
• Assuming many sellers automatically means perfect competition, without checking whether the product is differentiated.

As an example-to-structure identification, as a structure-to-characteristic match, or as a statements item listing the features of one structure.

• practice — not a real PYQ

  Free entry, many sellers and a homogeneous product together describe which one of the following market structures?

  • (a)Monopoly
  • (b)Oligopoly
  • (c)Perfect competition
  • (d)Monopolistic competition

  Answer(c) Perfect competition — homogeneity is what removes any pricing power from the individual seller.

• practice — not a real PYQ

  Heavy expenditure on advertising and brand-building is most characteristic of which one of the following market structures?

  • (a)Perfect competition
  • (b)Monopolistic competition
  • (c)Pure monopoly
  • (d)Monopsony

  Answer(b) Monopolistic competition — advertising is how a seller creates and defends the differentiation its pricing power rests on.