Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 10] PRICE AND OUTPUT UNDER MONOPOLISTIC COMPETITION AND OLIGOPOLY 249
(b)
(c)
When the monopolistically competitive market is in long-run equilibrium, the price charged by each firm
exceeds the LMC of the last unit produced. Therefore, resources are underallocated to the firms in the
market and misallocated in the economy. This misallocation of resources is not large, however, because
the demand curve facing the monopolistically competitive firm, although negatively sloped, is highly elastic.
Though some advertising is useful (since it informs consumers), the amount of advertising undertaken
by monopolistically competitive firms may be excessive. This only adds to costs and prices. Similarly,
some product differentiation is beneficial since it gives the consumer a greater range of choices. However,
an excessive number of brands, styles, designs, etc., only serves to confuse the consumer and adds to costs
and prices.
10.7 Compare the long-run equilibrium point of the firm in Problem 10.5 to the long-run equilibrium point of
a perfectly competitive firm with the same LAC curve.
In Fig. 10-12, A 00 is the long-run equilibrium point for the monopolistically competitive firm of Problem 10.5.
If this had been a perfectly competitive firm instead (with the same LAC curve), it would have produced at point E
when the industry is in long-run equilibrium. Thus, the cost of production and price of the monopolistically competitive
firm is $6 rather than $5 and its output is 6 rather than 9 units. As a result, there is an underallocation of
resources to the monopolistically competitive firm. The higher cost of production and price under monopolistic
competition results from product differentiation, some of which, at least, has economic value since it gives the consumer
a greater range of choices. The smaller output of each firm under monopolistic competition allows more firms
to exist and results in excessive capacity and overcrowding.
Since d 0 is tangent to LAC at point A 00 , the monopolistic competitor breaks even, does not produce at the lowest
point on its LAC curve, and underutilizes a smaller-than-optimum scale of plant when the industry is in long-run
equilibrium.
Some waste from excessive advertising and model changes is likely to take place in monopolistic competition,
but not under perfect competition (where the product is homogeneous and the firm can sell all it wants at the going
market price). These effects become smaller as the elasticity of d 0 increases.
10.8 Can you give the reasons why the theory of monopolistic competition has fallen somewhat into
disrepute in recent years.
The theory of monopolistic competition has fallen somewhat into disrepute recently because:
(1) It may be difficult to define the market and determine the firms and products to include in it. For example,
should moist paper tissues be included with other paper tissues or with soaps? Are toothpaste, dental floss,
toothpicks, and water picks part of the same market or product group?
Fig. 10-12
(2) In markets in which there are many small sellers, the demand curve facing monopolistic competitors is nearly
horizontal, so that the model of perfect competition is appropriate to use.
(3) In markets in which there are strong brand preferences, the product usually turns out to have only a few sellers,
so that oligopoly is the relevant model.