Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What is monopolistic competition?

1. A market with one producer and perfect substitutes

2. A market with many producers featuring product differentiation

3. A market where all firms produce identical goods

4. A market focused solely on price competition

The correct answer is: A market with many producers featuring product differentiation

Monopolistic competition refers to a market structure characterized by many producers who sell products that are differentiated from one another. Each firm offers a product that, while similar to those of its competitors, has distinct features, branding, or quality that set it apart. This differentiation allows firms to have some degree of market power, which gives them the ability to set prices above marginal cost without losing all their customers. In a monopolistically competitive market, firms compete not only on price but also on other attributes such as quality, customer service, and brand image. This competition encourages innovation and marketing, leading to a variety of choices for consumers. Monopolistic competition contrasts markedly with perfect competition, where products are identical, and firms are price takers without any market power. Firms in monopolistic competition also face a downward-sloping demand curve, indicating that they can increase prices without losing all their customers, which is a further aspect of their distinct competitive positioning. Overall, this market structure is prevalent in industries like retail, restaurants, and consumer goods, where many alternatives exist for consumers but no single producer dominates the market.