Compared with perfect competition, quantity produced in monopolistic competition is inefficient as price is higher than marginal cost (i.e. allocative inefficiency). Why do some economists argue that even if price is higher than marginal cost, it does not necessarily imply inefficiency?
1. De Beers is a monopolist which supplies diamonds with constant marginal cost and constant average total cost.
a) Draw the average cost, marginal cost, demand and marginal revenue curves. Show the price charged by De Beers without price discrimination.
b) Use the diagram drawn in (a), label the area of De Beers’s profit with X, of consumer surplus with Y, and of deadweight loss with Z.