Monopolistic Competition
Monopolistic competition is a form of imperfect competition and can be found in many real
world markets ranging from clusters of sandwich bars and coffee stores in a busy town centre to
pizza delivery businesses in a city or hairdressers in a local area. Small-scale nurseries and
care homes for older people might also fit into the market structure known as monopolistic
competition.
Price and
Cost
MC
P1
AC
AC1
AR
MR
Q1
Quantity of Output
The assumptions of monopolistic competition are as follows - as you check through them look
to see the differences between this mark structure and perfect competition.
1. There are many producers and many consumers in a market - the concentration ratio
is low
2. Consumers perceive that there are non-price differences among the competitors'
products i.e. there is product differentiation
3. Producers have some control over price - they are “price makers” rather than “price
takers.”
4. The barriers to entry and exit into and out of the market are low
http://www.tutor2u.net/blog/index.php/economics/
In the short run the profits made by businesses competing in this type of market structure can
be at any level - in our example below the business is making supernormal profits indicated by
the shaded area. One of the predictions of the model is that high levels of abnormal profit will
attract new suppliers and new products into the market the effect of which might be to reduce
the demand for existing products and reduce profits down towards normal profit equilibrium.
Strong brand loyalty can have the effect of making demand less sensitive to price.
The long run equilibrium may be as shown in our second diagram - with normal profits being
made. The reality is that a stable equilibrium is never reached - new products come and go all
of the time, some do better than others. Existing products within a market will typically go
through a product life cycle which affects the volume and growth of sales.
MC
Price and
Cost
AC
P2 = AC2
AR
MR
Q2
Quantity of Output
One of the possible implications of monopolistic competition is that an inefficient outcome is
reached. Prices are above marginal cost and saturation of the market may lead to businesses
being unable to exploit fully the internal economies of scale - causing average cost to be higher
than if the market was being supplied by less firms and products. Critics of heavy spending on
marketing and advertising argue that much of this spending is wasted and is an inefficient use
of scarce resources. The debate over the environmental impact of packaging is linked strongly
to this aspect of monopolistic competition.
Case Study: Competition in the market for nursery education
Recently, one leading company has taken the decision to withdraw from the nursery market,
whereas another has set a clear strategy to achieve market leadership through acquisitions.
What lies behind the different approaches?
In August 2007 Nord Anglia decided to sell its market-leading nursery operation for less than
half the price it paid to build the business. Nord Anglia sold its 88 kindergartens to Busy Bees,
an Australian-owned company, for £31.2 million. It blamed over-capacity in the nursery market
and the lack of economies of scale as the main reasons for the disposal. In 2006, Nord Anglia
made a loss of £3.5 million on its nursery operation, on turnover of £47.1 million. For Busy
Bees, the acquisition catapulted the business into the number one position in the nursery
market, giving it a total of 134 nurseries across the UK. John Woodward, the entrepreneur who
founded Busy Bees with a single site 25 years ago wants to make Busy Bees into a “major
childcare brand”.
http://www.tutor2u.net/blog/index.php/economics/
The UK nursery market is worth around £500 million and is currently highly fragmented, with
some 85% of operations being “mom and pop” style individual sites. The total number of private
nurseries is around 15,000. One problem facing all nursery operators is that the business is
labour-intensive. One member of staff is needed to look after every three babies or seven
toddlers. Nursery staff costs are around 60% of revenue. To be sustainable, a nursery has to be
at least 60% full in each of its ten sessions in a week, although many customers choose not to
use a nursery for a full week.
Source: Business Café, September 2007
http://www.tutor2u.net/blog/index.php/economics/