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Chapter 13: Problem 2

Why is a monopolistically competitive firm not productively efficient? In what sense does a monopolistically competitive firm have excess capacity?

Short Answer

Expert verified
A monopolistically competitive firm is not productively efficient as it does not produce at the minimum of its average total cost curve. This is a result of market control which enables the firm to set its prices above marginal costs. Also, a monopolistically competitive firm has excess capacity because it produces less than the output at which average total cost is minimized. This is triggered by entry of new competitors, causing a leftward shift of the individual firm's demand curve till it intersects with the average total cost curve.

Step by step solution

01

Understanding Monopolistic Competition

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another. They are not perfect substitutes, hence producers have some control over price.
02

Productive Efficiency in Monopolistic Competition

A monopolistically competitive firm is not productively efficient because it does not produce at the lowest point on its average total cost curve. This is mainly due to product differentiation, which allows firms to maintain some level of market control and keep prices above marginal costs.
03

Excess Capacity

Excess capacity refers to a situation in which a firm is producing at a lower scale of output than it has been designed for. A monopolistically competitive firm has excess capacity because in the long run, new entrants move into the market, causing the demand curve of each firm to shift inward, until they are no longer covering costs, leading to a situation where they could potentially produce more, but the market demand is simply not there.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Imperfect Competition
In economics, imperfect competition refers to market structures that fall between the extremes of perfect competition and monopoly. Monopolistic competition is a prime example of imperfect competition. This occurs when numerous firms sell similar but not identical products.
This differentiation gives firms some control over pricing, unlike in a perfectly competitive market where firms are price takers. Since products are not perfect substitutes, firms can influence consumer preference through marketing and brand loyalty.
  • Market Power: Each firm has some degree of market power allowing them to set prices above marginal costs.
  • Differentiation: Firms compete on factors other than price, such as quality and branding.
  • Entry and Exit: The industry allows for easy entry and exit, which impacts firm profitability.
Understanding imperfect competition helps explain why firms in these markets are not always operating at peak efficiency. They must balance between attracting customers and managing costs, but the room for price adjustments provides a unique dynamic that's absent in perfectly competitive environments.
Productive Efficiency
Productive efficiency occurs when a firm produces at the lowest possible cost, using the least amount of resources. In ideal cases, this is achieved at the lowest point on the average total cost (ATC) curve. However, in a monopolistically competitive market, firms are rarely productively efficient.
Firms in such markets often operate on a point of their ATC curve higher than the minimum. This inefficiency is a direct consequence of product differentiation.
With each firm offering slightly different products, they have less pressure to minimize costs because consumers may still opt for their product even if priced higher.
  • Cost and Price: Product differentiation lessens the need to compete purely on price.
  • Scale of Production: Firms do not typically operate at the lowest cost per unit due to smaller scales of production.
  • Resource Allocation:** This inefficiency leads to suboptimal resource allocation across the market.
Without the push to minimize costs, resource usage drifts away from what's considered efficient in a perfect competition scenario.
Excess Capacity
Excess capacity is a condition where a firm produces below its full potential output level. This is common in monopolistic competition, where entry and exit of firms in the market affect capacity utilization.
Over time, new firms enter the market, driven by the allure of profits. This leads to a decrease in demand for each individual firm's product, pushing the demand curve inward.
  • Operating Below Capacity: Firms operate at levels below full capacity because demand does not justify higher production.
  • Economic Implications:** It leads to economies operating below optimal output, which could have been avoided in a more efficient market structure.
  • Idle 91影视: Some resources remain unused, reflecting a misallocation that could theoretically meet demand if redistribution was possible.
Excess capacity represents a viable opportunity for consumers to benefit from potential increased output if market conditions allowed better utilization of resources.

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Most popular questions from this chapter

A skeptic says, "Marketing research and brand management are unnecessary. If a company wants to find out what customers want, it should simply look at what they're already buying." Do you agree with this comment? Explain.

(Related to Solved Problem 13.3 on page 461 ) In recent years, McDonald's has faced increased competition from other fast-food restaurants. In an attempt to differentiate itself from fast-food competitors, McDonald's has responded by remodeling some restaurants to include kiosks that customers can use to pay for their orders and to request table service. Remodeling a restaurant can cost as much as \(\$ 60,000 .\) McDonald's expects that customers will spend more on food when they order with kiosks. Suppose McDonald's begins to earn an economic profit in the restaurants offering table service and kiosks. a. How are other fast-food restaurants likely to respond? b. Is this new strategy likely to enable McDonald's to earn an economic profit in the long run? Briefly explain.

In 2008 , Gogo became the first company to offer Wi-Fi service on commercial aircraft. It provides the service primarily through ground-based cellular towers. Many air travelers find the \(\$ 30\) price Gogo charges on a cross- country flight to be very high because the speeds offered are too slow to stream movies or other content. Gogo faces competition from newer services that use satellites rather than ground-based towers, which enables them to offer much higher speeds at half the price Gogo charges. According to an article in the Wall Street Journal, in late 2016 , Gogo was "rolling out an advanced satellite-based network" that would allow it to offer higher speeds at a lower price. A number of airlines, though, were considering switching to competing services. a. Will copying its competitors by offering a faster, lower-priced service likely allow Gogo to recapture its market share? b. Unlike its competitors, Gogo had to spend substantial amounts to build a network of ground-based cellular towers. It has to abandon those towers as it switches to a satellite-based network. Is the cost of those towers a disadvantage to Gogo as it competes with the new firms entering the industry? Briefly explain.

An article in the Wall Street Journal described the marketing philosophy of Whole Foods Market, a supermarket chain that sells many food products that have no preservatives or artificial sweeteners (Amazon.com acquired Whole Foods after this article was published): Whole Foods has long divided its 462 stores into 11 regions, each with distinct product offerings like local maple syrup and gourmet pickles. A quarter of Whole Foods shoppers that visited the chain in the past month did so for items they couldn't find elsewhere.... For those who shopped at Wal- Mart Stores Inc., only \(3 \%\) said exclusive brands were the top draw. a. Explain why Whole Foods does not achieve productive efficiency by offering its customers "distinct product offerings" and "exclusive brands." b. Briefly explain how Whole Foods' product differentiation may benefit its customers more than if the supermarkets achieved allocative and productive efficiency.

A student makes the following comment: I can understand why a perfectly competitive firm won't earn a profit in the long run because it charges a price equal to marginal cost. But a monopolistically competitive firm can charge a price greater than marginal cost, so why can't it continue to earn a profit in the long run?
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