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CA Foundation · Business Economics · Price Determination in Different Markets

In the long-run equilibrium of a monopolistically competitive firm, the firm produces an output of 400 units, whereas its minimum average cost occurs at 600 units. How is the gap of 200 units best described?

The 200-unit gap is excess capacity. In long-run equilibrium the firm's demand curve touches the falling part of the average cost curve, so output is below the minimum-cost level. The firm therefore operates below efficient scale, a known inefficiency of monopolistic competition.

  1. AExcess capacity, showing the firm operates below its efficient scaleCorrect
  2. BExcess demand, showing a shortage in the market
  3. CSupernormal profit, showing room for entry
  4. DEconomies of scale being fully exhausted

Explanation

In the long run the demand curve is tangent to the downward-sloping part of the average cost curve, left of the minimum point. Output is therefore less than the cost-minimising output. This shortfall (600 - 400 = 200 units) is called excess capacity. Profit is only normal at tangency, so supernormal profit is wrong.

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