Producer surplus - The amount that

producers benefit by selling at a market

price that is higher than the lowest price at
which they would be willing to sell.

Consumer surplus - The difference between

the maximum price a consumer is willing to
pay and the actual price they do pay.
 Monopolistically competitive market can
never achieve productive or allocative
efficiency.

Two sources of Inefficiencies

When price exceeds Marginal Cost,
deadweightloss has created
When it operates with excess capacity
 The monopolistic firm does not
achieve allocative efficiency.
Allocative efficiency requires that
Price = Marginal Cost
Price = Marginal Cost
vs.
Price > Marginal Cost
 Consumers will have to pay a higher
price leading to a significant decline in
consumer surplus;

Some consumers must forgo the

product because of its higher price.
Excess capacity means that fewer firms operating
at capacity could supply the industry output.

Excess capacity is the gap between the minimum

ATC output and the profit-maximization
output, (plant and equipment that are
underused because firms are producing less
than min ATC output.)
(Price > Minimum Average Total Cost)
Productive efficiency requires that
Price = Minimum Average Total Cost
Price = Min ATC
vs.
Price > Min ATC

To use their excess capacity, they would have to

produce a quantity equal to their minimum
ATC.
Product differentiation creates excess capacity
 The demand curve of monopolistic
competition is elastic but not perfectly elastic

Products are somewhat substitutable.

-because although the firms are selling
differentiated products, many are still close
substitutes, so if one firm raises its price too
high, many of its customers will switch to
products made by other firms.
 Demand is downward sloping demand
curve.

Thus, its marginal revenue will always be

less than the market price, because it can
only increase demand by lowering prices,
but by doing so, it must lower the prices of
all units of its product.

This is also caused by relative ease of entry

and exit
 The greater the differentiation of the products,
the greater the inefficiency. However, this greater
diversity is more likely to satisfy consumer tastes,
which leads to a more desirable market

In a monopolistically competitive market, the

consumer must collect and process information
on a large number of different brands to be able
to select the best of them. The result is that the
consumer is confused. Some brands gain prestige
value and can extract an additional price for that.
 Lack of Specialization: Under monopolistic
competition, there is little scope for specialization
or standardization. Product differentiation
practiced under this competition leads to wasteful
expenditure. It is argued that instead of producing
too many similar products, only a few standardized
products may be produced. This would ensure
better allocation of resources and would promote
economic welfare of the society.

Inefficiency : Under perfect competition, an

inefficient firm is thrown out of the industry. But
under monopolistic competition inefficient firms
continue to survive.