A firm in monopolistic competition is able to earn abnormal profits if it is maximizing its profit by producing at the level of output where MC = MR, and the AC is less than the selling price. A firm is productively efficient if it produces at the lowest possible cost per unit, which is at the point where MC = AC. Allocative efficiency is when the firm produces at the socially optimum level of output, which is where MC = AR. In other words, the demand curve reflects the signal that consumers send out to producers about how much of a product the consumers need and want. The point of allocative efficiency is where the benefit of society equals the firm’s cost. If a firm in monopolistic competition is earning abnormal profits, it is neither productively nor allocatively efficient. Since it produces at the profit maximizing output, where the marginal cost is equal to the marginal revenue, the output produced is q. Since the firm is profit seeking, it does not produce at q1 (productively efficient) or at q2 (allocatively efficient). The inefficiency is not, however, due to the firm's ability to restrict output and increase price (as it is in a monopoly). The inefficiency is due to the consumer's demand for variety. Even though the products are not produced at the "socially optimum level of output", consumers are not worse off with monopolistic competition than with perfect competition. The monopolistic competition provides variety in the products for consumers to choose from, so the consumers do not suffer from the firm's lack of allocative and productive efficiency.
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