In discussing industries that are neither monopolies nor p-competitive, economists have tended to begin from the four characteristics of a p-competitive industry. We recall that those characteristics are:
Competition can be "imperfect" in an industry if the industry deviates from any one of the four. Thus, if there are just a few firms (but more than one), deviating from the first characteristic, the industry is said to be an "oligopoly." Since the nineteen-twenties, economists have also discussed the situation when an "industry" deviates only in the second characteristic. This is called "monopolistic competition," and we have "monopolistic competition" when a group of firms sell closely related, but not homogenous products. Instead, the products are said to be "differentiated products." Thus, the characteristics of "monopolistic competition" are:
To say that products are differentiated is to say that the products may be (more or less) good substitutes, but they are not perfect substitutes. For an example of a monopolistically competitive "industry" we may think of the hairdressing industry. There are many hairdressers in the country, and most hairdressing firms are quite small. There is free entry and it is at least possible that people know enough about their hairdressing options so that the "sufficient knowledge" condition is fulfilled. But the products of different hairdressers are not perfect substitutes. At the very least, their services are differentiated by location. A hairdresser in Center City Philadelphia is not a perfect substitute for a hairdresser in the suburbs -- although they may be good substitutes from the point of view of a customer who lives in the suburbs but works in Center City. Hairdressers' services may be differentiated in other ways as well. Their styles may be different; the decor of the salon may be different, and that may make a difference for some customers; and even the quality of the conversation may make a difference. A very good friend of mine changed hairdressers because her old hairdresser was an outspoken Republican. My friend said that she just couldn't take it any more without answering back -- and it's not a good idea to get into a controversy with one's haircutter!
