Microeconomics Question from Walter E. Williams:[]
"Monopolistic competition is inefficient." Explain and evaluate that assertion. Then defend the proposition that neither Pareto optimality nor efficient allocation is a relevant criteria for real decision making in the honest-to-god world.
Answer[]
As Harold Hotelling demonstrated with the problem of the two hot dog vendors on the beach, monopolistic competition can lead to inefficient outcomes. Because each vendor is trying to capture the largest portion of market share, they both end up at the middle of the beach which is not optimal from the vantage point of customers, yet neither vendor would be better off if he were to move. Prisoner dilemma games demonstrate that neither pareto optimality nor efficient allocation have to be relevant for real decision making. Individuals seek to maximize their own utility and firms seek to maximize profits which do not always lead to pareto optimal and efficient conditions.
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