Final answer:
The question explores why the loss of economic efficiency is relatively small in competitive markets compared to monopoly, with a focus on how competition brings prices closer to marginal costs, reducing deadweight loss. In monopolistic competition, the industry self-regulates through entry and exit of firms to reach zero economic profits or losses in the long run, underscoring the importance of competition in promoting economic efficiency.
Step-by-step explanation:
The question deals with the concept of economic efficiency and how it is affected by market structures such as perfect competition and monopolistic competition. In a perfectly competitive market, firms produce where price equals marginal cost, resulting in allocative efficiency since the benefits to society from the production equal the marginal costs. However, in a monopolistically competitive market, firms charge a price greater than marginal cost, leading to allocative inefficiency since the produced quantity is less and the price is higher than in a perfectly competitive market. This is due to different demand curves—the perfectly competitive firm faces a horizontal demand curve (price equals marginal revenue), while the monopolistically competitive firm faces a downward-sloping demand curve. The loss of economic efficiency is small primarily because in most industries that are not monopolies, competition keeps the price much closer to marginal cost, hence minimizing deadweight loss.
In monopolistic competition, if firms are earning economic profits, new entries occur until these profits are driven down to zero. Conversely, if the industry is suffering economic losses, firms will exit until losses are eliminated, which brings about a long-run equilibrium. This dynamic market adjustment curtails substantial inefficiencies. Nevertheless, the perfectly competitive model is the benchmark for efficiency, leading to the most efficient allocation of resources and production at the lowest average cost.