Monopolistic Competition

Up to the early 1920s the classical theory of price included two main models, pure competition and monopoly. Duopoly models were considered as intellectual exercises rather than real-world situations. The general model of economic behaviour from Marshall to Knight1 was pure competition. In the late 1920s economists became increasingly dissatisfied with the use of pure competition as an analytical model of business behaviour. It was obvious that pure competition could not explain several empirical facts. The assumption of a homogeneous product, in the theory of competition, did not fit the real world. Furthermore advertising and other selling activities, practices widely used by businessmen, could not be explained by pure competition. Finally, firms expanded their output with falling costs, without however growing infinitely large, as the pure competition model would predict in the event of continuously decreasing costs.