Which of the following best describes the efficiency of monopolistically competitive firms?

• A. They are neither allocatively nor productively efficient in the long run.
• B. They are allocatively efficient but not productively efficient in the long run.
• C. They achieve both allocative and productive efficiency in the long run.
• D. They are productively efficient but not allocatively efficient in the long run.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the definitions of allocative and productive efficiency. Allocative efficiency occurs when firms produce the quantity of output where price equals marginal cost (\(P = MC\)), meaning resources are allocated to produce what consumers value most. Productive efficiency occurs when firms produce at the lowest point on their average total cost curve (\(ATC\)), minimizing costs per unit.
2. Step 2: Recall the characteristics of monopolistic competition in the long run. Firms have some market power due to product differentiation, and free entry and exit drive economic profits to zero, but firms do not produce at minimum average total cost because of excess capacity.
3. Step 3: Analyze allocative efficiency in monopolistic competition. Since firms have downward sloping demand curves and set prices above marginal cost (\(P > MC\)), they do not achieve allocative efficiency.
4. Step 4: Analyze productive efficiency in monopolistic competition. Because firms do not produce at the minimum point of their average total cost curve (due to excess capacity), they are not productively efficient in the long run.
5. Step 5: Combine these insights to conclude that monopolistically competitive firms are neither allocatively nor productively efficient in the long run.