Many small enterprises, such as restaurants and clothing stores, operate under a market structure known as "monopolistic competition." Such firms operate in a competitive market while differentiating their products by implementing some unique elements to compete for the same pool of customers. Though monopolistic competition allows businesses to thrive in a competitive environment, it has both advantages and disadvantages.
Monopolistic competition is characterized by few barriers to market entry; it is easy for new firms to enter and leave such markets without facing the many barriers in pure monopoly markets; this allows creativity and an active business environment with ample competitors. The less restrictive market structure ensures that no one firm plays as a monopoly and consumers get a variety of products or services from which to choose. Businesses running in this market structure make business decisions based on various economic factors such as cost of production, the market and the type of products they are offering.
Monopolistic competition requires consumers to become more informed about the products and services available in the market. Businesses entering a monopolistic competition market often engage in advertising to make their presence known and differentiate themselves from other local businesses offering the same products. Due to completion, firms under this market structure have to enhance their visibility in the market through aggressive advertising and marketing. In return consumers are fed information concerning unique aspects of products such as pricing, packaging and other special services through advertising channels like radio and local newspapers. Consumers in monopolistic competition environments can therefore become well informed about products and services in their market and can make informed choices based on their knowledge.
Companies functioning in monopolistic competition market have to differentiate their products from those of their competitors. Differentiated products ensure that consumers can choose a product from a company, for example, for its unique qualities such as the color of the packaging, size or price. Due to the competitive nature of the market, companies strive to find a distinctive feature to differentiate its products from those of its competitors offering the same type of product. For example, a company selling detergent often differentiates its product through easily recognizable packaging.
Most local companies under monopolistic competitive market enjoy some level of liberty. Though the market is free and open to other companies, a local company can often adjust prices upward without attracting competition. In addition, a local firm enjoys repeat business from local customers who remain loyal irrespective of price changes or the quality of services offered.
Monopolistically competitive firms incur high expenses in marketing and advertising; advertising is expensive, and monopolistically competitive companies have to spend to make their presence in the market known. In monopolistic competition, firms make an extra effort to differentiate their products in the view of stiff competition using methods such as product packaging, unique marketing and distribution channels to differentiate their products. This becomes an additional cost which makes operating costs high.