Chamberlin theory has been severely criticised by a number of economists like Stigler, Coten and Cyert. The evils and defects of monopolistic competition, which are generally spoken of as ‘wastes of competition’ are as follows.
1. Interdependence:
The assumption that the firms take decisions independently and ignore the possible reactions by their competitors has been criticised on the ground that the products under monopolistic competition are close substitutes to one another.
The very fact that the firms resort to product differentiation implies that they are aware of the market structure and actions as well as possible reactions of their competitors. Actually, the assumptions of product differentiation and independent actions by the rivals are inconsistent.
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2. Naive Behaviour:
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Chamberlin’s implicit assumption of naive behaviour that firms do not learn from their past experience is not empirically observed. The firms fail to believe that their price revision decisions would provide similar reactions from competitors. Even after experiencing the reaction, they do not change their mode of behaviour. They continue to reduce their prices, which may even lead to further rise in their losses.
3. Product Differentiation and Free Entry:
According to some critics, the assumption of product differentiation is incompatible with the assumption of free entry. Actually, product differentiation prevents free entry of new firms. New firms have to incur heavy advertising cost in order to make their product known and attract customers from already established firms. Truly speaking, product differentiation and brand loyalty of customers create a barrier to entry for new firms, especially, completely new ones.
4. Wastes on Advertisements:
Availability of different types and qualities of goods under monopolistic competition enables the consumers to exercise their choice in the purchase according to their preferences. When advertisement renders the real service to the consumers by giving them details about the availability of varieties of the product and other true facts to enable them to compare prices and qualities of products, then, it is desirable.
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Such advertisement reduces search cost for buyers as well as sellers and makes market to function efficiently. However, firms rarely use such informative advertising. They often deceive the consumers regarding the qualities of the products offered by them by resorting to aggressive manipulative advertising.
Producers of various soft drinks spend huge amount of money on obnoxious and dubious advertising. Consumers have to bear costs of such advertising compaigns. It is a waste of financial resources. It is also a social waste, as competitive advertisements by rival producers cancel one another.
Advertising encourages market concentration and unfair trade practices. Its abuses need to be curbed by legislation and consumer awareness. Further, the existence of too many varieties of a product confuses the consumers and result in irrational preferences for inferior varieties.
5. Group Boundaries:
According to George Stigler (the most severe critic of Chamberlin theory), the concept of ‘group’ in Chamberlin theory is ambiguous. Boundaries of the group under monopolistic competition cannot be clearly demarcated. Chamberlin does not define the actual number of firms necessary to justify the myopic disregard of competitor’s actions and to classify it as monopolistically competition rather than as oligopoly.
6. Excess Capacity:
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Excess capacity is one of the important defects of monopolistic competition. As explained earlier, firms under monopolistic competition do not increase their output to the level, where the average cost is minimum. By producing at less than optimum level, the firms use their invested resources inefficiently.
Moreover, the availability of goods to the society is less than optimum. Even Chamberlin admitted that non-price competition coupled with free entry leads to excess capacity under monopolistic competition. This implies that the resources are not fully utilised. Further, the firms fail to specialise sufficiently on account of non-price competition and frequent product variation.
Under monopolistic competition, a number of inefficient firms can survive even in the long run due to ‘consumer loyalty’. On account of manipulative advertising, the consumers get a wrong impression that the commodities produced by these firms are good.
The inefficient firms incur chronic losses, charge high price from the consumers and waste valuable resources. A developing country like India with limited resources cannot afford the luxury of unutilised capacity, inefficient firms and too many varieties of the same commodity.
7. Transport waste:
The wasteful use of transport facilities is the direct result of product differentiation and irrational consumers’ preferences. The unnecessary expenditure on the transportation of goods to far flung areas is a sheer wastage. It would be much better, if a single firm serves a particular area. In that case, excessive cross-transport cost could be avoided.
It is, thus, clear from the above discussion that Chamberlin’s heroic model is not acceptable as an approximation to the real world in which demands and cost conditions are different among the various firms. This model of monopolistic competition has been criticised for vagueness of concepts. Inspire of the above criticisms, Chamberlin’s contribution to the theory of pricing is indisputable.
(i) Introduction of realistic and crucial policy decision variables like product differentiation and selling cost opens up avenues for further exploration and brings the price theory closer to reality. While product differentiation satisfies human desire for variety and choice, informative advertising provides useful information to the consumers saving their time, money and energy on evaluating products. These tools are the basis of non-price competition, which is the typical form of competition today.
(ii) He introduced the concept of the share of the market demand curve ‘D’, which along with perceived demand curve ‘d’ gave rise to the ‘kinked demand curve’. Paul Sweezy, Hall and Hitch have widely used it as a possible explanation of oligopolistic behaviour. (See next chapter on pricing under Oligopoly under heading ‘Price Rigidity under Oligopoly’, page 377 for details).
(iii) Chamberlin emphasised that monopoly and competition are not mutually exclusive. His theory of monopolistic competition recognised both elements concurrently.