When the loss from a business-stealing externality exceeds the gain from a product-variety externality,
A)firms are more likely to operate at efficient scale.
B)there are likely to be too many firms in a monopolistically competitive market.
C)market efficiency is likely to be enhanced by the entry of new firms.
D)all firms are earning zero economic profit.

Question

Quizplus · Accepted Answer

In a monopolistically competitive market, firms differentiate their products and can earn economic profit in the short run due to product-variety externalities. However, if the loss from business-stealing externalities (where a firm's customers are lured away by a competitor's similar product) exceeds the gain from product-variety externalities, then there are too many firms in the market. This is because each firm is trying to differentiate its product while also stealing customers from its competitors, leading to inefficiency and potential losses for all firms. Therefore, it would be more efficient if some firms exited the market, leading to less product differentiation and less stealing of customers.

When the Loss from a Business-Stealing Externality Exceeds the Gain