Introduction
Excess capacity is a concept in microeconomics that is often discussed in the context of monopolistic competition. It refers to a situation where a firm produces less than the level of output that minimizes its average total cost. In simpler words, the firm is not using its full productive capacity, meaning that it could produce more at a lower cost per unit but chooses not to due to market conditions.
Definition of Excess Capacity
Excess capacity is the difference between the actual output produced by a firm and the output level at which the firm’s average cost is the lowest (i.e., optimal scale of production). It is usually seen in monopolistic competition where firms do not produce at minimum average cost due to lack of perfect competition.
Causes of Excess Capacity
- Product Differentiation: In monopolistic competition, firms produce slightly different products. Due to brand loyalty and limited market share, each firm produces less than optimal capacity.
- Downward Sloping Demand Curve: Firms face downward-sloping demand curves, so to sell more, they must lower prices. This discourages them from expanding output to the point of minimum average cost.
- Lack of Competition: When firms have some market power, they restrict output to maximize profits, even if that means not fully utilizing their resources.
Implications of Excess Capacity
- Indicates inefficiency in the market
- Firms operate on the falling portion of their average cost curves
- Resources are underutilised
- Consumers may enjoy variety but at a higher cost
Example
Suppose a bakery can produce 1,000 loaves of bread daily at the lowest average cost. But due to limited customer demand, it only produces 700 loaves. The difference (300 loaves) represents its excess capacity.
Conclusion
Excess capacity is a key feature of monopolistic competition. It shows that firms are not operating at the most efficient scale. While it reflects some level of consumer satisfaction due to product variety, it also indicates resource wastage and higher costs. Policymakers and economists often study excess capacity to evaluate market efficiency and competition levels.