Monopolistically competitive industries are inefficient because:

• A. firms always set price equal to marginal cost
• B. firms do not produce at the minimum point of their average total cost curves
• C. products are perfectly homogeneous and consumers have no preference
• D. there are significant barriers to entry preventing new firms from entering the market

Answer: (B)

Verified step by step guidance

1. Understand the characteristics of monopolistic competition: many firms, differentiated products, and free entry and exit in the long run.
2. Recall that in monopolistic competition, firms maximize profit by setting marginal revenue (MR) equal to marginal cost (MC), but because of product differentiation, the price (P) is greater than MC.
3. Recognize that firms in monopolistic competition produce where average total cost (ATC) is not minimized, meaning they operate with excess capacity.
4. Note that this inefficiency arises because firms face downward-sloping demand curves and cannot produce at the minimum point of their ATC curve, unlike perfectly competitive firms.
5. Conclude that the main source of inefficiency in monopolistic competition is that firms do not produce at the minimum point of their average total cost curves, leading to higher prices and less output than the socially optimal level.