Question

What is the main similarity and two key differences that distinguish monopolistically competitive markets from perfectly competitive ones in the long run? Explain why monopolistically competitive firms are considered to be less efficient than the perfectly competitive ones.

Answer 1

The similarity between perfect competition and monopolistic competition is that both the markets would end up earning zero profits in the long run irrespective of whether they earn positive profits or negative profits.

Two differences between the monopolistically competitive and perfectly competitive firms are:

a) In the long run,the monopolistic competitive firms produces an output level which is below its efficient scale whereas in a perfectly competitive firm,the firm produces an output level which is at the efficient scale.

b) In monopolistic competitive market,the firms are price makers as their products are differentiated and their demand curve is downward sloping whereas in the perfect competition,the firms are price takers as they produce an identical product and their demand curve is perfectly horizontal.

The monopolistically competitive firms are considered less efficient because in the long run,they will produce an output level which is below its minimum ATC level, so the firm will under utilize its resources and have an excess capacity which represents the social costs for the firms whereas a perfectly competitive firm produces at an output level where the P=MC= minimum ATC so its efficient.