Question

6. What is an Excess Capacity Theorem? Why do you think it is faced by a monopolistic competitive market?

Answer 1

Monopolistically competitive firms are observed to be producing a level of output in the long run, which is less than their minimum efficient scale. The minimum efficient scale is the level of output at which average total cost is minimised. This implies that monopolistically competitive firm produces less than the minimum efficient scale and therefore it is considered to be having excess capacity which is not realised. This happens because these market structures have download sloping demand function and they produce a level of output in the long run, which although, results in zero economic profit, fails to achieve the productive efficiency. Hence, there remains excess capacity which is not realized.