Monopolistic Competition: A Form of Imperfect Competition in IB Economics, Slides of Marketing

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Monopolistic Competition

IB Economics: Theory of the Firm & Market Structures

Basics of Monopolistic Competition

• Monopolistic competition is a form of imperfect competition and can be found in many real world markets ranging from sandwich bars and coffee stores in a busy town centre to pizza delivery businesses in a city or hairdressers in a local area.
• Care homes for older people might also fit into the market structure known as monopolistic competition
• Monopolistic competition is similar to perfect competition, indeed some economists regard it as more realistic, because the products are differentiated
• Product differentiation means that businesses have some control over their products, it implies that firms have some price-setting power, AR slopes downwards

Assumptions: Monopolistic Competition

1. There are many producers and many consumers - the industry concentration ratio is low
2. Consumers are aware that there are non-price differences among products i.e. there is slight product differentiation – non-price competition is strong and plenty of consumer switching takes place 3. Producers have some control over price - they are “price makers” not “price takers” but the price elasticity of demand is higher than it would be under monopoly (the cross-price elasticity is high) 4. Barriers to entry and exit are low – this allows producers respond to changing profit signals and means profits are competed away in the long run

Short Run Price, Output and Profit

MC Price and Cost Output AC MR AR Firms have downward-sloping demand curves because they have some degree of price-setting power

Short Run Price, Output and Profit

MC Price and Cost Output AC MR AR P Q 1 C 1 Supernormal Profit At price P1 and Q1, supernormal profits are being made because Price > AC

Explaining Adjustment to the Long Run

• In the short run, profits competing in monopolistic competitive markets can be at any level
• Unlike monopoly, there are no barriers to entry
• So the presence of supernormal profits acts as a signal
• This means that short-run supernormal profit attracts new producers with new products and so normal profits only are made in the long run equilibrium i.e. where AR = AC
• As more firms enter the market, the demand curve for any existing firm shifts to the left as consumers opt to buy products offered by new or alternative companies.
• The demand curve continues to move to the left until it is tangential to the AC curve.
• At this point, the monopolistically competitive firm is at its profit-maximising level of output (because MR = MC) but is also making only normal profit (because AR = AC)

(2) Long Run Price, Output and Profit

MC Price and Cost Output AC MR AR P Q 2 In the long run equilibrium, the average revenue curve is tangential to AC – meaning normal profits are being made

A Stable LR Equilibrium is Unlikely

• In the long run equilibrium in monopolistic competition, the representative firm in the market is making normal profits.
• In reality, a stable equilibrium may not be reached since new products come and go, and some naturally do better than others. The market may be in a state of constant flux.
• Existing products within a market will typically go through a product life cycle that affects the volume and growth of sales
• The length of the product life cycle varies from market to market. Many businesses spend heavily on marketing / innovation to extend the life of profitable brands

Case Study: UK Taxi Industry

Addison Lee Founded by minicab driver John Griffin in 1975 with just one car, Addison Lee has become a major competitor to London's black cabs and now carries more than 10m passengers a year. Bought by Carlyle, the US hedge fund manager in July 2013 Private hire vehicles Mini cabs cannot be hailed from the street and must rely on telephone and internet bookings and walk-in reservations. Most private hire vehicles are licensed but there are also some un- licensed operators London Black Taxis There are over 23,000 black cab drivers. Entry is restricted to those with licence and drivers who have passed “the Knowledge” A fragmented market; There are an estimated 78,000 taxis and 153,000 licensed private hire vehicles in England and Wales. 80 % of UK taxis are relatively small owner-operator businesses. The industry as a whole generates revenues of nearly £9 billion per year

Case Study: UK Taxi Industry

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55.4 55. 0 10 20 30 40 50 60 70 80 90 1999 2001 2004 2005 2007 2009 2011 2013 Taxis in thousands London England/Wales

Price & Non-Price Competition in Gym Market

• The UK gym / health club industry generates >£2 billion of revenues annually with over 1,500 businesses employing nearly 40,000 people
• Gyms and fitness centres are concentrated in urban areas where high population density makes businesses more commercially viable
• The market position of mid-market gyms has come under pressure in recent years.
• Consumers are switching towards budget gyms , which do not require long-term contracts and charge less because they only offer basic services

Price & Non-Price Competition in Gym Market

Pay as you go Basic equipment Often out of town Many open 24 hours Dry facilities only – gym, classes Budget Gyms

• Membership subscriptions
• Wet (spa, pool) and dry facilities
• Car parking
• Restaurants
• Tailored instruction Mid-Range Gyms