Question

Does a monopolistic competitor produce more or less output as compared to an efficient level of production? Explain. What are the benefits and drawbacks of this? Should the government intervene to alter this?

Answer 1

The efficient level of production occurs where the P=minimum ATC

Whereas a monopolistic competition will produce where the MC=MR and in the long run,the firm will produce where the P=ATC but not at its minimum so there exist an excess capacity.

So, the output produced will be lower than the efficient level of production and the price charged will be higher. This shows an inefficient market as it is socially inefficient and there will be too many or too few firms in the market. If there are too many firms entering the market, this implies that the market has business-stealing externality and if there is too little entry of firms then it means that there is product variety externality in the market.The benefits of monopolistic competition is that the firms provide differentiated goods which gives more choice to the users and the firms compete through non-price competition.The government should not intervene in this market as this provides diversity and choice and is more practical than a perfectly competitive market.As these firms require high costs on advertisements and product differentiation, the market is not a monopoly one or where only a few firms dominate.