Incentives for Producers
As in perfect competition, there is a strong incentive for producers in monopolistic competition to strive to increase productive efficiency: faced with very little scope for increasing prices, firms in this situation find it very important to produce at the lowest possible cost per unit. Under monopolistic competition, however, there is the additional incentive to practice product differentiation, so as to widen the difference between your product and your competitors’, and thus gain an advantage in the marketplace. This could be achieved by actually making your product or service different from those of your competitors’ and by trying to persuade consumers that whatever differences exist are of importance to them.
Accordingly, we can expect sellers in monopolistically competitive industries to use considerable ingenuity and advertising and promotion to establish the ways in which they are different from their competitors – which they do. Restaurants stress their special menus, drinks, atmosphere, type of entertainment and so on. Retailers strive to establish their own “identity” through the character of their shops, special product lines, special services (delivery, exchanges, refunds, credit and so on).
This is not to say that Harry will raise his price to $1.10, only that he could. Harry’s problem is that he doesn’t know how far he can raise his price without losing too many sales; as a result, he is likely to be cautious about increasing his price. Many firms in this situation would decide to charge the same price as their competitors ($1.00), rather than risk a price increase that could have negative effects on their sales and profits.
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