Question

1. With the aid of an example, explain how product differentiation can act as an entry barrier and influence a firm’s demand in monopolistic competition?        
2. Monopolistic competition is sometimes criticized for displaying excess capacity. Using a fully labelled diagram, explain how product diffrerenciation can lead to excess capacity in long run equilbrium.                                                                        
3. With reference to your answer in a) and b) above, evaluate whether excess capacity is good or bad for society.                                                                               

1. With the aid of an example, explain how product differentiation can act as an entry barrier and influence a firm’s demand in monopolistic competition?        
2. Monopolistic competition is sometimes criticized for displaying excess capacity. Using a fully labelled diagram, explain how product diffrerenciation can lead to excess capacity in long run equilbrium.                                                                        
3. With reference to your answer in a) and b) above, evaluate whether excess capacity is good or bad for society.                                                                               

Answer 1

A.

One example of product differentiation is the product design that can be observed in Apple iPhones. It is patented work and it prohibits others from using it. So, it becomes an entry barrier in the market of monopolistic competition. It makes demand to remain high for the product like iPhones even if it is a monopolistic competition, because other firms cannot copy it fur to legal restrictions. It is the reason that iPhone is always sold at value based pricing.

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B.

Above condition is a long term equilibrium in the monopolistic competition. It can be observed that firm doing product differentiation is producing output at the level where ATC is not minimum. It is due to the reason that firm is price setter on the basis of product differentiation and want to put higher price. So, it reduces the output to the level of MR=MC and produce output level of Q. It causes excess capacity creation even if their is a long term equilibrium.

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C.

Excess capacity is bad for the society, because consumers are not getting more output in the market at lower price. Hence, firm is not achieving allocative or productive efficiency in the market. It means that resources available at disposal is not utilized efficiently and it is not good for the society.