Question

3. Compare the price and quantity outcomes delivered by monopolistically competitive and perfectly competitive industries. State and explain the implications for society about efficiency.

Answer 1

A perfect competitive industry and monopolistic competition differs in respect of price, output and economic efficiency. The perfect competitive industry consists of large number of small firms and each firm has a very little share in the total output of the industry. A monopolistic competition consists of limited number of firms compare to perfect competition and each firm has a large share in the total output of the industry. Under perfect competition each firm has to accept the market price and adjust the output according to the prevailing price. But under monopolistic competition each firm is a price maker. The firm can fix the price because each firm has monopoly power over its product which arises out of product differentiation and limited freedom of entry to the rivals in the market.

Under perfect competition the price is equal to marginal cost and marginal revenue. But in monopolistic competitive industry the price is above the marginal cost. The equality of price with marginal cost gives maximum welfare to the consumers under perfect competition or it is allocatively efficient. But a monopolistic competitive industry is allocatively inefficient since the price is above the marginal cost and it limits the social welfare.

Under perfect competition the firms in longrun expand the output to the lowest point of its average total cost. The reason is that the only way open to the firms to increase the profit is to increase the output so as to minimize the average total cost. But in monopolistic competitive industry, each firm limits the volume of output before the lowest point of its average total cost. Thus a competitive industry is productively efficient and maximizes the social welfare whereas a monopolistically competitive industry is productively inefficient and minimizes the social welfare.

Under perfect competitive industry the products are homogenous and perfect substitutes and the products are sold at a single price. Thus there is no need of selling cost. It means that there is no waste of resources in this industry. But in monopolistic competitive industry the products are differentiated but close substitute to each other. Each firm incurs selling cost to get large share in the market. The money spent for advertisement and other selling cost is added to the price of the product and the consumers are over burdened.

Under perfect competition the firms have incentive to produce at a lower cost. This leads to investment in inventions and innovations. The fruits of the new inventions and innovations are conveyed to the consumers in the form of low price. A monopolistic competitive market has less incentive to invest in cost reducing methods. Thus social benefit is large under perfect competition whereas in monopolistic competition the social benefit is limited.

In short a competitive industry ensures productive, Allocative and dynamic efficiency but a monopolistic competitive industry lack all these. The monopolistic competitive market is inefficient in case of social benefit.