Monopolistic Competition

I came across something in the CFA curriculum … which i am not sure is correct or not. It says that “A firm has excess capacity if it produces below its efficient scale, which is the quantity at which average total cost is the minimum” Shouldn’t a firm has excess capacity when it does produce at efficient scale. I am thinking if they produce at efficient scale, they will have to produce more and they will have excess capacity.

Your title is interesting. The statement is in reference to what the firms total output should be under optimal circumstances. For example, if you input 1 Y and out comes 10 X and the firm is operating efficiently as compared to if you input 1 Y and out comes 9 X, the firm has excess capacity to produce, because it isn’t operating efficiently. If the first case the ATC is 1Y / 10X and in the second case ATC is 1Y / 9X, which is greater. I’m not sure why you mention monopolies though.

When looking at long run ATC, it is at its minimum when it is flat (experienceing constant returns to scale, at its minimum efficient scale). I assume when producing at the minimum efficient scale (MES) the firm is profit maximizing, and thus using all of their capacity. So, if they are producing less, they are not meeting demand and have capcity to produce until MES.

It may help if you think of capacity as the max amount or upper limit. If they produce below that amount then there will be some amount more that they could produce that they aren’t. This is the excess capacity. As an example if their capacity is 10 and they are producing 8 they have 2 more in excess that they could produce. Hopefully that makes sense.

@DTM86 so in a way you are saying that excess capacity = amount they can produce - amount they do produce amount they can produce is at the minimum efficient level and amount they do produce is the point where MR=MC… right?

P=MR=MC should be minimum efficient scale. if they’re producing where MR>MC, they are producing a quantity below MES (where MR=MC) and have the capacity to produce more output until the point of MR=MC

i mentioned monopolistic competition, cause i came across this topic in that specific reading and i cant think why would anyone produce below minimum efficient scale in perfect competition because in the long run MR=MC=LRATC so the equilibrium point will be at the minimum efficient scale.

you’re definately right on that one! I was just trying to say that the firm does not produce Mr=MC for every unit, it only represents that last unit. So they produce UNTIL that point, and if they produce less, than MR>MC and they should (as you said) increase output until MR=MC at the MES

@ DIG i understand what you are saying, but in monopolistic competition or even Monopoly demand curve is above the MR curve, So the quantity produced may not have MR=MC=LRATC. What you are saying is correct for perfect competition, but i don’t think its right for the other two… i may be wrong… but this is what i think…

Sunny, I understand what you’re saying, but in a monopoly the firm does not produce the efficient level of output (the profit maximizing output is traced up to their demand curve). In monopolistic competition profit max in the long run is MR=MC and a price that makes such. Basically you find the q which makes MR=MC and trace it up to the demand curve which is tangent to the ATC in the long run. BUT, the allocation of production is still inefficient because it’s not at the min of ATC, hence the idea of…is prodcut differentiation done efficiently? I guess that for whatever type of firm we refer to, if a firm is producing below its minimum ATC, it could still have capacity to produce more with increasing returns to scale. So I agree with you and think the question in regards to monopolositc competition is vague.

schweser p. 104 figure 2 a

@ DIG What you are saying does make sense. Thank you for your help.