Question

Why don’t firms in a competitive market have excess capacity in the long run?

A. A competitive firm always produces as much as it can, because it knows that other firms will also produce at their maximum capacity.

B. For the types of goods produced in competitive markets, it is difficult to store any goods that cannot be sold immediately, so it does not make sense to invest in capital that provides the potential to produce more than the market can consume.

C. For competitive firms, marginal revenue equals marginal cost at the point where marginal cost equals average total cost.

D. Excess capacity exists only when firms are making economic profits, and firms in competitive markets always earn zero economic profit due to free entry and exit.

E. In the long run, competitive firms produce at a level at which price is lower than marginal revenue and earn zero profit.

Answer 1

C. For competitive firms, marginal revenue equals marginal cost at the point where marginal cost equals average total cost.

Explanation :

Excess capacity is the difference between profit maximising quantity and allocatively efficient quantity. In long run, perfectly competitive firm earns zero economic profit and firm produce where MR equals MC and minimum ATC.

MR=MC =minimum ATC. So, there is no excess capacity as profit maximising quantity and allocatively efficient are equal.