Which of the following best exemplifies a firm with excess capacity?

• A. An oligopoly producing at the socially optimal output level
• B. A perfectly competitive firm operating at the minimum point of its average total cost curve
• C. A monopoly producing at the point where marginal cost equals marginal revenue
• D. A monopolistically competitive firm producing below the minimum point of its average total cost curve

Answer: (D)

Verified step by step guidance

1. Understand the concept of excess capacity: Excess capacity occurs when a firm produces at an output level less than the quantity that minimizes its average total cost (ATC), meaning it is not fully utilizing its productive potential.
2. Review the characteristics of different market structures: Perfect competition firms produce at the minimum point of their ATC curve, oligopolies and monopolies produce where marginal cost equals marginal revenue, but monopolistically competitive firms often produce below the minimum ATC due to product differentiation and downward-sloping demand.
3. Identify the condition for excess capacity: A firm has excess capacity if it operates on the downward-sloping portion of its ATC curve, producing less than the output that minimizes ATC, which implies it could increase output and lower average costs.
4. Match the options to the concept: The monopolistically competitive firm producing below the minimum point of its ATC curve fits the definition of excess capacity because it does not produce at the lowest possible cost per unit.
5. Conclude that the correct example of a firm with excess capacity is the monopolistically competitive firm producing below the minimum point of its average total cost curve.