Multiple Choice QuestionA major trade-off that occurs in monopolistically competitive industries is that, as product differentiation increases,Multiple choice question.allocative efficiency also increases.productive efficiency also increases.consumer choice decreases.excess capacity also increases.
Question
Multiple Choice QuestionA major trade-off that occurs in monopolistically competitive industries is that, as product differentiation increases,Multiple choice question.allocative efficiency also increases.productive efficiency also increases.consumer choice decreases.excess capacity also increases.
Solution
The correct answer is: excess capacity also increases.
Here's why:
In monopolistically competitive industries, firms have some degree of market power because each firm's product is unique in some way. Therefore, they face a downward-sloping demand curve. As product differentiation increases, each firm can act more like a monopoly, setting its price above marginal cost.
However, this comes with a trade-off. As firms differentiate their products more, they also tend to produce less than the socially optimal level of output, leading to excess capacity. This is because each firm is trying to avoid competition with other firms by making its product different, but this also means that each firm is not fully utilizing its resources to produce as much as it could if it were acting like a perfectly competitive firm.
So, as product differentiation increases in monopolistically competitive industries, excess capacity also increases. This is a major trade-off that these industries face.
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