Question

How does monopolistic competition affect society’s welfare?

Answer 1

Monopolistic competition is characterised by large number of firms selling differentiated products having substitutes. There is freedom to entry and exit which results in firms earning normal profits in the long run.

Monopolistic competition attains equilibrium at a point where MR = MC, like undr a monopoly. Thus it under-produces and over -charges for its products, creating a deadweight loss

Moreover, the number of firms in a monopolistically competitive market may not be optimal, due to the external effects from the entry of new firms:

i) product-variety externality:

Because the consumers get some consumer surplus from the introduction of new products with the entry of new firms in the market, such an externality is positiive in nature and is known as the product variety externality.

ii) business stealing externality:

Other firms lose business and profit to the new entrant, resulting in a negative externality on existing firms, known as business stealing externality.

While the inefficiencies of monopolistic competition are hard to measure, yet they do not have all the desirable welfare properties of perfect competition market.