Explain why, in long-run equilibrium, monopolistically competitive markets are neither productively nor allocatively efficient

AQA A-Level Economics Paper 1 June 2023

Explain why, in long-run equilibrium, monopolistically competitive markets are neither productively nor allocatively efficient. (15 marks)

1. Monopolistic competition is a market structure with low barriers to entry and slight product differentiation. 
2. The diagram below shows a firm’s cost and revenue curves in the short-run.
3. In the long-run, new firms enter the market. 
4. Since existing firms are making supernormal profit, new firms are incentivised to join the market. 
5. This is possible since there are low barriers to entry.
6. As a result, market supply increases. 
7. Each firm therefore loses market share which causes marginal revenue and average revenue decrease.
8. The diagram below shows that in the long-run, firms are only able to make normal profits.
9. Firms continue to aim to profit maximise so they set output at the level where MC=MR.
10. This leads to an output of q1 and a price of p1 in the long-run.

1. This level of output is not productively efficient because at q1, marginal cost does not equal average cost. 
2. Productive inefficiency means that firms are not operating at the lowest point of their average cost curve.
3. In the long run, this means that firms are not fully exploiting their economies of scale. 
4. It also means they are unable to pass down the lowest possible prices to consumers.
5. Firms are also allocatively inefficient in the long-run.
6. This is because, at q1, average revenue does not equal marginal cost.
7. If firms are not allocatively efficient, it means that consumer surplus is not maximised in the market.
8. Firms are not dynamically efficient either as they are not able to make supernormal profits in the long-run.
9. This means that they are unable to consistently re-invest and innovate their products.

A-Level Economics Tutoring

I offer one-to-one and small group A-Level Economics tutoring for students across the UK and internationally. With 87+ five-star Google reviews and tutoring experience since 2017, I specialise in helping students understand difficult concepts and improve their exam technique.