CDS (I) 2022 General Knowledge · Question 62 of 120

Correct — A, 1 and 2 only. Monopolistic competition is the market form that borrows one feature from perfect competition and one from monopoly. From perfect competition it takes a large number of buyers and sellers, none of them big enough to set the market price alone — factor 2. From monopoly it takes product differentiation: every seller offers something the others do not exactly reproduce, by formulation, brand, packaging, location or after-sale service — factor 1. Differentiation is what gives each firm its own downward-sloping demand curve and a sliver of price-setting power, and it is why advertising and other selling costs matter in this market and hardly at all in the others. Barriers to entry, factor 3, are exactly what monopolistic competition lacks: entry and exit are free, which is why any supernormal profit pulls in new firms until only normal profit survives in the long run. Homogeneous products, factor 4, are the defining assumption of perfect competition and the flat contradiction of factor 1 — no market can have both at once.

• (b)1, 2 and 3 only — Adds barriers to entry. Free entry and exit is one of the standing assumptions of monopolistic competition and is the mechanism that erodes long-run profit to normal; barriers belong to monopoly, and in a softer form to oligopoly.
• (c)3 and 4 only — Both halves fail. Barriers to entry are absent here, and a homogeneous product describes perfect competition — the very assumption that differentiation replaces.
• (d)2 and 4 only — Keeps the true large-numbers condition but pairs it with homogeneous products, which would make the market perfectly competitive rather than monopolistically competitive.

Monopolistic competition was described independently by Edward Chamberlin and Joan Robinson in 1933, to cover the very common case that neither perfect competition nor monopoly fits: many small firms selling close but not identical substitutes. Each firm faces a demand curve that slopes downward, because some buyers will pay a little more for its particular version, but the curve is highly elastic, because the substitutes are close. Free entry means the long-run equilibrium leaves each firm producing less than the output at which average cost is lowest — the excess-capacity result — and earning only normal profit.

Statements 3 and 4 are each borrowed from a different market structure, and each can be knocked out on its own. Barriers to entry are the defining feature of monopoly; a homogeneous product is the defining assumption of perfect competition. Because 1 and 4 contradict each other outright, any option holding both is impossible — that alone disposes of (c) and (d), and dropping 3 disposes of (b), leaving (a). Everyday examples are the safest memory aid: soaps, toothpastes, biscuits, salons and neighbourhood restaurants are all many-seller markets where the product is deliberately made to feel different from the one next to it.

• Monopolistic competition: many buyers and sellers, differentiated products, free entry and exit, and a little price-setting power for each firm.
• Perfect competition: many buyers and sellers, a homogeneous product, free entry, and a perfectly elastic demand curve facing the individual firm.
• Monopoly: a single seller, no close substitutes, and strong barriers to entry.
• Oligopoly: a few sellers whose decisions are interdependent, with significant barriers to entry.
• Selling costs and advertising are characteristic of monopolistic competition, because differentiation is worth nothing unless buyers are told about it.

• Treating differentiated and homogeneous products as compatible; they are mutually exclusive by definition.
• Importing barriers to entry into monopolistic competition because the word monopolistic appears in the name.
• Assuming a monopolistically competitive firm keeps supernormal profit in the long run; free entry removes it.

Either as a features checklist like this one, or as a real-world market to be classified — the market for soaps, the Indian Railways, a retail vegetable market.

• practice — not a real PYQ

  In the long run, a firm operating under monopolistic competition earns

  • (a)supernormal profit
  • (b)only normal profit
  • (c)persistent losses
  • (d)no revenue at all

  Answer(b) only normal profit — free entry lets new firms compete away any supernormal profit until price equals average cost.

• practice — not a real PYQ

  Which one of the following is a feature of perfect competition but not of monopolistic competition?

  • (a)A large number of sellers
  • (b)Free entry and exit of firms
  • (c)A homogeneous product
  • (d)Absence of a single dominant buyer

  Answer(c) A homogeneous product — the other three are shared; differentiation is what separates the two market forms.