Evaluation of Monopolistic Competition
There is excess capacity under monopolistic competition as profit maximization takes place at sub-optimal scale. The firm, therefore, has excess capacity of O3Q. Thus, it is sometimes argued that the firms in monopolistic competition are inefficient. However, this is due to the downward sloping demand curve due to which tangency cannot be at minimum AC and does not necessarily implies inefficiency The downward slope of demand curve is due to product differentiation which is of value to the customers For example, Haldiram’s products are likely to cost more than generic brands, because many buyers are willing to pay the extra price as an assurance of quality. In general, the validity or the claim that the monopolistic competition is inefficient depends on a comparison of the benefits derived from product differentiation and the increased costs caused by differentiated products.