Question

Monopolistic competition is said to be inefficient. Give reasons of its market inefficiency.

Answer 1

The first reason of inefficiency is that at its optimum output, the firm charges a price that exceeds marginal costs. The monopolistic competitive company maximizes profits where marginal revenue equals marginal cost. The demand curve is downward sloping, meaning it will charge a price that exceeds marginal costs. At a monopolistic competitive firm's profit maximizing level of production there will be a net loss of consumer and producer surplus.

The second reason is that these companys operate with excess capacity. The company’s profit maximizing output is less than the output associated with minimum average cost. All companys produce to a point where demand or price equals average cost regardless of the type of market it operates. The demand curve for a monopolistic competitive company is downward sloping. In the long run, this leads to excess capacity.

Markets that have monopolistic competition are inefficient for two reasons