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Inefficiency

There are two sources of inefficiency in the MC market structure. The first source of inefficiency is that, at its optimum output, the company charges a price that exceeds marginal costs. The MC company maximises profits where marginal revenue equals marginal cost. Since the MC company's demand curve is downwards-sloping, the company will charge a price that exceeds marginal costs. The monopoly power possessed by a MC company means that at its profit-maximising level of production, there will be a net loss of consumer (and producer) surplus. The second source of inefficiency is the fact that MC companies operate with excess capacity. That is that the MC company's profit-maximising output is less than the output associated with minimum average cost. Both an MC and PC company will operate at a point where demand or price equals average cost. For a PC company, this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average cost. An MC company's demand curve is not flat but is downward-sloping. Thus, the demand curve will be tangential to the long-run average cost curve at a point to the left of its minimum. The result is excess capacity.