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Chapter 13: Problem 3

Why is a monopolistically competitive firm not allocatively efficient?

Short Answer

Expert verified
A monopolistic firm is not allocatively efficient because it is able to sell its product at a price higher than the marginal cost. This is possible due to product differentiation that gives some monopoly power to each firm, which results in produced quantities of goods not aligning with the quantities that are demanded by consumers.

Step by step solution

01

Understanding Monopolistic Competition

A monopolistically competitive market is one in which many firms sell products that are similar but slightly differentiated. Because of the product differentiation, each firm has some monopoly power, i.e., some control over the price of its product.
02

Understanding Allocative Efficiency

Allocative efficiency is a state of the economy in which production represents consumer preferences. In other words, produced quantities of goods match the quantities being demanded. It exists when the price of goods equals its marginal cost.
03

Inefficiency in Monopolistic Competition

In a monopolistically competitive market, the price of a good is greater than its marginal cost. This is because each firm has some monopoly power due to product differentiation. Hence, the firm is able to sell its product at a price higher than the marginal cost of production. As a result, the production does not represent consumer preferences entirely i.e., quantities of goods produced do not match the quantities being demanded. Consequently, there is a failure in achieving allocative efficiency.

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Most popular questions from this chapter

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.

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In \(1916,\) Ford Motor Company produced 500,000 Model T Fords, at a price of \(\$ 440\) each. The company made a profit of \(\$ 60\) million that year. Henry Ford told a newspaper reporter that he intended to reduce the price of the Model \(\mathrm{T}\) to \(\$ 360\), and he expected to sell 800,000 cars at that price. Ford said, "Less profit on each car, but more cars, more employment of labor, and in the end we get all the total profit we ought to make." a. Did Ford expect the total revenue he received from selling Model Ts to rise or fall following the price cut? b. Use the information given above to calculate the price elasticity of demand for Model Ts. Use the midpoint formula to make your calculation. (See Chapter 6 , page \(186,\) if you need a refresher on the midpoint formula.) c. What would the average total cost of producing 800,000 Model Ts have to be for Ford to make as much profit selling 800,000 Model Ts as it made selling 500,000 Model Ts? Is this smaller or larger than the average total cost of producing 500,000 Model Ts? d. Assume that Ford would make the same total profit when selling 800,000 cars as when selling 500,000 cars. Was Henry Ford correct in saying he would make less profit per car when selling 800,000 cars than when selling 500.000 cars?
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