Question

Evaluate the following claim: “Monopolistically competitive industries are strictly worse than perfectly competitive industries because long run monopolistic competition involves inefficient allocation of resources and product differentiation is wasteful.” Your answer should take into account the efficiency and the consumer welfare implications of both types of industry structures. Diagrams are not required, (but you may choose to use them if you think it will help)

Answer 1

There are below types of efficiencies:

- Allocative Efficiency: This type of efficiency is achieved when the price charged = marginal cost. It implies that all the resources available are allocated efficiently. Each firm in the market earns normal profit and there is no score for additional costs like deadweight loss.

- Technical Efficiency: This is achieved when the price charged = Minimum point of average cost curve. Such point is called Minimum Efficient Scale and ensure that production takes place with least cost.

Both types of efficiencies are achieved in perfect competition. Under the market, firm is the price-taker and P = MC = Minimum AC.

So, perfect competition is the most desirable position from individual firm and from society point of veiw.

However, in a monopolistic competition, things are bit different. Under this market, equilibrium takes place when MR = MC. So, allocative efficiency is not obtained.

Also, the equilibrium point under this market falls to the left of minimum point of average cost curve. So, it is also no technically efficient.

Monopolistc competition is therefore considered as inefficient. The market is always characterized by EXCESS CAPACITY and the resources are underutilized.

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