Tag Archives: socially optimal price

Monopolistic Competition: Price and Output

27 Jul

monopolistic competition

Efficiency
   Economic efficiency requires the following triple equation P=MC=minimum ATC. The equality of price and minimum ATC yields productive efficiency (and results in fair price return). The goods are produced in least costly way, and the price is just sufficient to cover average total costs (ATC), so the firm gets a normal profit. The equality of price and MC yields in allocative efficiency(and results in socially optimal price). So, the right amount of output is produced , and the scarce resources are used in the most efficient way.
   But, is monopolistic competition efficient as measure by our triple equation?

Productive and Allocative efficiency
   In monopolistic competition, neither productive nor allocative efficiency is achieved in long-run. Since in this kind of market system profit-maximizing price is slightly higher than lowest average total cost (ATC) then this results in productive inefficiency(society has to pay higher than optimal price for some goods). Also, firms in monopolistic competition have profit-maximizing prices which are higher than marginal cost (MC), that’s why monopolistic competition causes an underallocation of resources. Society values each addition unit of output higher than goods it would have to forgo to produce these items. That’s why monopolistic competition fails the allocative-efficiency test. Consumers pay higher than optimal price and get less than optimal output. Besides, monopolistic competitors must charge higher-than-optimal-price to get a normal profit.

Excess Capacity
   In monopolistic competition, the difference between the minimum average total cost (ATC) output and profit-maximizing output identifies excess capacity: underused plant or equipment because the firm produces less that minimum ATC output. If the monopolistic competitive firms produce at minimum ATC output, then the quantity supplied totally by all firms will be very high, so product will be sold at lower price. That’s why this type of market system is overcrowded by firms that produce bellow their optimal capacity. An example of this situation can be the high number of mini-markets or super-markets in each city that operates at less than their half capacity.

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