It’s been a while since we have treated ourselves (and we hope you) to one of our occasional pieces on applying basic economic concepts to problems in higher education.
Today, we want to take a look at the idea of “monopolistic competition”, a notion introduced to the profession by Edward Chamberlin and separately by Joan Robinson in the 1930s.
Classically, economists have distinguished between competitive industries and monopolies. Under “perfect” competition, a number of firms produce an identical product (wheat) and all sell it at the same price, a price determined by the market and not the individual firm. In “pure” monopoly one firm is uniquely equipped to sell a certain product and has control over some resource that stops other firms from selling the same product or a close substitute. Microsoft Office, drugs whose patents have not expired, and cable companies that are the sole providers in a city are good (if not perfect) examples of monopolized products. A monopolist can dictate the price, and will maximize profit by restricting supply and charging a higher price than would prevail under competition.
Between these two extremes are oligopolies, in which a small number of firms share the monopoly advantage and the resulting profits – think Verizon, AT&T, Sprint, and T-Mobile.
Monopolistic competition also falls in between the extremes, but closer to the competitive end. There are lots of firms selling similar but not identical products. They compete with one another, but each of them is selling something a little different from the others. Each can nudge the price up a bit from the competitive level, but the monopoly pricing can’t be pushed very far, because customers are happy enough just to go elsewhere. Unlike monopolists and oligopolists, firms in monopolistic competition can’t maintain excess profits because consumers have lots of available substitutes from which to choose. Coffee shops and local restaurants are familiar examples.
The downside of monopolistic competition, relative to perfect competition, is that that little bit of market power every firm has results in higher prices and lower output than would be ideal from the point of view of customer satisfaction and resource use. The upside is that consumers can choose among slightly differentiated products that serve pretty much the same purpose. This model is a pretty good fit for small not-for-profit colleges that lack a strong national brand. There are a great many colleges like this, often with a historical commitment to a religious group. They tend to compete fiercely with one another for students. Many of them would function better if they were modestly bigger – it’s tough to sustain anything like a complete undergraduate education with fewer than 600 or 800 students. But to get to that enrollment level, they would have to discount tuition so severely that they might not be able to pay the bills.
This part of the higher-education market might work better if there were 25-percent fewer colleges each serving a third more students (e.g., compare 1,200 colleges each serving 600 students with 900 colleges each serving 800 students). But getting there from here is a very hard problem to solve. No one of these colleges is eager to close up shop and cede its students to a set of competitors. Presidents on the whole like being presidents, and trustees and alumni often feel family or religious ties to a particular place.
In a for-profit industry with this kind of market structure the more successful firms can buy up the less successful ones or push them out of business, frequently creating a chain of establishments. This movement toward consolidation has been a highly visible trend in industries like hotels, restaurants, and banking. Back forty years ago, the roadside motel might have had unique charms – but it might also have been the Bates motel. Now it’s most likely to be a Holiday Inn Express or a Ramada or the like – the industry has become more like an oligopoly, dominated by a few large firms. In a geographically mobile society, consolidation makes it easier for a traveler to predict what his or her experience will be like at a local restaurant or motel and for a stranger to cash a check at the local bank. On the other hand, service becomes more impersonal and the opportunity to discover that unique local diner or to swing a business loan at a bank that knows and trusts you is reduced. Moreover, there is less competition and prices are likely to be higher.
Consolidation among small private colleges would have similar pros and cons. But the mechanism of the strong operators buying the weaker ones – available to banks and hotels – is not available. Not-for-profit firms are not “owned” in the way businesses are. The trustees hold the place in trust and cannot walk away with any cash from selling it. Instead, mergers have to be arranged and the many local interests involved in a particular school get a voice. Thus, even under great financial pressure, small colleges have a tendency to keep going. This of course contributes significantly to the richness and variety of American educational institutions. At the same time, “keeping going” may involve compromising quality or asking students to take on very heavy debt to pay the bills. It also leaves the small colleges more vulnerable to competition from aggressive for-profit competitors, organizations with no constraints on their ability to open, close, and consolidate campuses.
This analysis does not offer answers to these dilemmas, but does show how some simple economic tools help illuminate the choices available and the consequences of different paths.
