Why does inefficiency exist in monopolistic competition?
Inefficiency of monopolistic competition is a result of product differentiation. Firms differentiate their products to meet consumers' demand. The gains from product diversity can be large and may easily outweigh the inefficiency associated with a downward-sloping demand curve. As a result, we see a long-run equilibrium quantity at which MC does not equal ATC indicating that the firm is not producing with productive efficiency. It could increase output and achieve lower average total costs. In addition, we see a long-run equilibrium quantity at which MC is less than price which indicates allocative inefficiency. The firm could have produced more benefit for society if it had produced a greater quantity where MC equaled price. The firm is not willing to do either of these at long-run equilibrium because an increase in output would result in a loss.
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