Recall that:

• productive efficiency is P= min ATC
• Allocative efficiency is P= MC

I. A monopolistic competition industry has neither productive nor allocative efficiency
A. Marginal revenue curve will never coincide with D=AR=P

• in monopolistically competitive market, Demand is relatively elastic. Products are somewhat substitutable.

B. Firms produce at a point where P>MC, meaning that resources are underallocated; not allocatively efficient
C. Firms do not produce where P= min ATC; therefore, no productively efficient
D. In the long run, MC industries will only earn a normal profit. P= ATC (but not minimum ATC!)
E. This is also caused by relative ease of entry and exit

• When profits are earned, more firms will enter (easy to enter/ exit) and demand for an individual firm decreases (shifts to the left). This causes an individual firm's profits to decrease. Demand curve becomes more elastic.
• When there are losses, firms will leave (easy to enter/ exit) and demand for an individual firmincreases (shifts to the right). This causes an individual firm's profits to increase. Demand curve becomes less elastic.

II. Product differentiation creates excess capacity
A. Excess capacity means that fewer firms operating at capacity could supply the industry output.
B. Excess capacity is the gap between the minimum ATC output and the profit-maximization output, indicating that the firm is operating below optimal capacity (plant and equipment that are underused because firms are producing less than min ATC output.)
C. The greater the product differentiation, the greater the productive inefficiency
D. The industry is overcrowded by firms to operate at its optimal capacity
*If firms is able to produce product at P = min ATC, they could have same amount of product at lower price