Talk about the idea of surplus capacity in relation to the long-term equilibrium in the context of monopolistic competition.
Discuss the concept of excess capacity associated with the long run equilibrium under Monopolistic competition.
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Talk about the idea of surplus capacity in relation to the long-term equilibrium in the context of monopolistic competition.
Excess Capacity in Monopolistic Competition
Excess capacity is a key feature in the long-run equilibrium of firms operating under monopolistic competition, a market structure characterized by many firms selling differentiated products.
Product Differentiation and Market Power: In monopolistic competition, firms have some degree of market power due to product differentiation. This allows them to set prices above marginal costs, unlike in perfect competition.
Entry of New Firms and Erosion of Profits: In the long run, the presence of profits attracts new firms to the market, increasing competition. As new firms enter, the demand faced by each existing firm decreases, shifting their demand curves to the left.
Long-Run Equilibrium with Excess Capacity: Eventually, firms reach a long-run equilibrium where they produce at a level less than the minimum efficient scale – the output level at which average total costs are minimized. This results in excess capacity, where firms have underutilized resources or operate below their optimal scale.
Implications: Excess capacity in monopolistic competition indicates inefficiency, as firms could produce at a lower average cost if they operated at a larger scale. However, this inefficiency is the trade-off for having a variety of products and the benefits of competition in terms of choice and innovation.
In summary, the long-run equilibrium of monopolistic competition typically involves firms operating with excess capacity, a consequence of the entry of new firms and the market power derived from product differentiation.