9.6 Signposting

Question 1

Monopolistic Competition Long Run Performance

Answer 1

1. Monopolistically competitive firms produce outcomes that are allocatively inefficient. This is because
   consumers are charged prices greater than marginal cost at the profit maximising level of output.
2. Firms in monopolistic competition are productively inefficient. This is because they do not produce at the minimum point on the average cost curve choosing instead to voluntarily forgo some economies of scale.
3. Dynamic efficiency is not being achieved in the long run. This is because supernormal profits are not being made in the long run thus restricting a monopolistically competitive firm’s ability to re-invest back into the business.

Question 2

Monopolistic Competition Long Run Performance Evaluation

Answer 2

1. The allocative inefficiency of firms in monopolistic competition arises out of consumer demand for differentiated goods. Consumers are willing to pay slightly higher prices than marginal cost for product variety and greater choice preferring this than the product homogeneity of perfect competition even though there is static efficiency and lower prices in perfect competition
2. The productive inefficiency of monopolistic competition again arises from consumer demand for differentiated goods. The variety that firms give consumers makes it harder to achieve productive efficiency and exploit full economies of scale. However this does not translate into significantly higher prices that perfect competition and the loss of efficiency is not as significant as that in monopoly
3. The notion that firms are always dynamically inefficient due to a lack of supernormal profit in the long run may not hold in reality. Firms may be forced to re-invest short run supernormal profits or even long run normal profits in order to stay ahead of rivals and compete in such a fiercely competitive market.