Q.What is meant by 'excess capacity' under monopolistic competition? Why does it arise?
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Start your 14-day free trial to unlock the full solution →Meaning. In the long run a monopolistically competitive firm earns only normal profit, so its AR curve is tangent to its AC curve at the equilibrium output. Excess (unused) capacity is the difference between this actual output and the larger output at which AC would be minimum — the plant is not worked to its most efficient level.
Why it arises. Because each firm's product is differentiated, its AR (demand) curve slopes downward. A downward-sloping curve can be tangent to a U-shaped AC curve only along AC's falling portion — that is, to the left of the minimum point of AC. Hence the tangency (long-run equilibrium) occurs before AC reaches its lowest point, and the firm stops short of the least-cost output. Under perfect competition, by …
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