Monopolistic Competition - KAA and Evaluation Paragraphs

In this short video we look through example KAA and evaluation paragraphs on this question: "Assess the extent to which monopolistic competition leads to economic efficiency."

KAA Paragraph

In monopolistic competition, we assume that there are many firms each selling slightly differentiated products and the barriers to entry are low. An example might be many sandwich shops competing in a city centre. Intense competition between suppliers means that demand is likely to be price elastic (Ped>1) which then means that prices may move closer to marginal cost. Therefore, in contrast to a monopoly, prices for consumers will be lower and this would be an improvement in allocative efficiency of scarce resources.

Evaluation Paragraph

However, firms in monopolistic competition still have pricing power since AR and MR are downward sloping. This is especially true for firms with strong brand loyalty. Even if the entry of new firms & products means that normal profits are made in the long run, price will remain above marginal cost so allocative efficiency is not achieved. The saturation of many differentiated products in monopolistically competition may also lead to a loss of productive efficiency as firms are unable to fully exploit economies of scale in the long run.