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CMA Foundation · Fundamentals of Business Economics and Management · Forms of Market

A firm in monopolistic competition is in long-run equilibrium. Compared with the output at which average cost is at its minimum, its output is generally:

The firm produces less than the output at minimum average cost, which is called excess capacity. Its downward-sloping demand curve touches the average cost curve on the falling part, so price exceeds marginal cost and the firm does not fully use its most efficient scale.

  1. AEqual to the minimum average cost output, because price equals marginal cost
  2. BGreater than the minimum average cost output, because of advertising
  3. CLess than the minimum average cost output, showing excess capacityCorrect
  4. DZero, because normal profit leaves no reason to produce

Explanation

In long-run equilibrium the demand curve is downward sloping and tangent to the average cost curve on its falling portion. Output is therefore below the point of minimum average cost. This gap is called excess capacity, and the firm charges a price above marginal cost.

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