Monopolistically competitive product markets are inefficient because:

• A. firms do not produce at the minimum point of their average total cost curves
• B. firms always set price equal to marginal cost
• C. there are significant barriers to entry preventing competition
• D. products are perfectly homogeneous

Answer: (A)

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 have some market power, allowing them to set prices above marginal cost, unlike perfect competition where price equals marginal cost.
3. Recognize that firms in monopolistic competition produce where marginal revenue equals marginal cost, but this output level is less than the output that minimizes average total cost (ATC).
4. Note that because firms do not produce at the minimum point of their ATC curve, there is excess capacity, leading to inefficiency in the market.
5. Conclude that the inefficiency arises primarily because firms do not produce at the minimum average total cost, unlike perfectly competitive firms that do.