The Excess-Capacity Theorem
Part (ii) of Figure 11-2 makes it clear that monopolistic competition
results in a long-run equilibrium of zero profits, even though each
individual firm faces a negatively sloped demand curve. It does this by
forcing each firm into a position in which it has excess capacity; that is,
each firm is producing an output less than that corresponding to the
lowest point on its LRAC curve. If the firm were to increase its output, it
would reduce its cost per unit, but it does not do so because selling more
would reduce revenue by more than it would reduce cost. This result is
often called the excess-capacity theorem.
In long-run equilibrium in monopolistic competition, goods are produced at a point where
average total costs are not at their minimum.In contrast, the long-run equilibrium under perfect competition has price
equal to the minimum of long-run average costs. In part (ii) of Figure
2 , this is shown as point with price and output (Recall that
with perfect competition, each firm faces a horizontal demand curve at
the market price, so at price each firm would be on its MC curve at
point )
The excess-capacity theorem once aroused passionate debate among
economists because it seemed to show that all industries selling
differentiated products would produce them at a higher cost than was
necessary. Because product differentiation is a characteristic of virtually
all modern consumer goods and many service industries, this theorem
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