Question

Monopolistic Competition Suppose a perfectly competitive market for hot-dog stands in New York City changes when gourmet, discount, and ethnic hot-dog retailers show up, making each cart slightly different. With the inclusion of the new vendors, hot-dog stand owners are now engaged in monopolistic competition. If hot dogs from different stands are imperfect substitutes and there are numerous carts in the city, compare the producer and consumer surplus and total social welfare before and after the change.

Answer 1

The market is previously perfectly competitive and in later stage it turns into a monopolistically competitive one. Consumer surplus is reduced during this transformation because the price is increased and the quantity is reduced. for the same reason producer surplus is increased during this transformation

However it is also to be noted that decline in the consumer surplus is greater than the increase in producer surplus which implies that social surplus overall reduces. Due to this there is a creation of deadweight loss.