The very name of this market type suggests that it is a combination of the monopoly and competitive firms. The characteristics of such a market are:

1. There exists large number of firms in the industry.

2.There is product differentiation. That is, the products of the firms are close substitutes of each other. The product of each firm has a brand name which marks the difference in quality, packaging or reputation. The amount of monopoly power a firm possesses depends on how successfully it can differentiate and propagate its brand.

3. Free entry and exit of firms from the industry is allowed.

4. Decisions are taken by the firms independently.

The model of monopolistic competition was developed by Chamberlain. He extended the ideas of monopoly and competition to a group of firms dealing with class of product. He first analyzed the group assuming that all the firms had uniform cost and demand. He then considered what would happen if diverse conditions existed.

Therefore, under monopolistic competition the optimal price is higher and the level of output could be lower than under perfect competition. The profits of the firms may or may not be higher because of the expenditure required to maintain the degree of monopoly power. Chamberlin argues that monopolistic competition will not necessarily bring higher profits to the marginal firm in the industry but all the existing firms will make normal profits.