Monopolistic competition is a market structure defined by four main characteristics: large numbers of buyers and sellers; perfect information; low entry and exit barriers; similar but differentiated goods. This last one is key to distinguish monopolistic competition from perfect competition since in the latter all products are homogenous. This product differentiation leads consumers to perceive products in this market as unique, providing firms with a monopolistic-like property that enables them having price-making power. There is a distinction to be made between horizontally and vertically differentiated products in order to be able to understand different strategies that monopolistic firms might adopt. The former is given when consumers base their purchasing decision on subjective preferences when comparing products, e.g. colours or flavours. The latter occurs when the product can be evaluated with another one in terms of measurable and qualitative factors, e.g. technological differences or technical properties in engines.
The extent to which each firm can take advantage of their monopoly condition depends on the flexibility of their demand curve. If it is too rigid (steeper), in order for the monopolist to achieve a higher price, it has only to reduce some of its production. However the more flexible (flatter) the demand curve is, the less market power the firm has to increase prices. Naturally, every monopolist in an imperfect market tries to expand the size of the market in which its product dominates. For this they have to compete with other monopolists leading them to a series of costs other than production (manufacturing and transportation costs), which are defined as selling expenses. These expenses are incurred with the aim of modifying the demand curve so quantities demanded for the product increase for each level of prices.
If a firm fails to have its product differentiated, the market would be shared with other firms, turning into a duopoly, oligopoly or even, if other conditions are met, a perfectly competitive market.
Within the field and existing research of monopolistic competition, the most prominent model is the one devised by Edward H. Chamberlin (the Chamberlin model), which he developed from monopoly models. Even tough there are other models and theories, most have followed Chamberlin’s model, being this the most widely used and recognized in economics.