Compare and contrast the outcomes with respect to price and output in a monopolistically competitive market and a perfectly competitive market. In which situation are consumers better off? Why?

Question

What will be an ideal response?

Answer 1

Assuming the demand and cost conditions are the same, price will be higher and output will be lower under monopolistic competition than it will under perfect competition. The profit-maximizing monopolistically competitive firm produces the level of output at which MR = MC and then sets price based on the demand curve. As such, because the monopolistically competitive firm's demand curve is downward sloping, P > MC. In contrast, P = MC = MR for the perfectly competitive firm. Consumers get more output at a lower average price and, in this regard, are better off under perfect competition than they are under monopolistic competition. That being said, monopolistically competitive firms offer consumers something perfectly competitive firms do not, i.e., choice. (Recall that the output of the firms in a perfectly competitive market is homogeneous.) Product differentiation gives consumers greater choice. There is thus a trade-off between price and choice and so it is not clear in which situation consumers are better off.