Which of the following best represents the excess capacity of a firm operating under monopolistic competition?

• A. The total fixed costs incurred by the firm
• B. The gap between the firm's price and its average variable cost
• C. The difference between the firm's output at minimum average total cost and its actual output
• D. The amount by which marginal cost exceeds marginal revenue

Answer: (C)

Verified step by step guidance

1. Understand the concept of excess capacity in monopolistic competition: it refers to the difference between the output level where average total cost (ATC) is minimized and the actual output produced by the firm.
2. Recall that in monopolistic competition, firms produce less than the output at minimum ATC because they have some market power and face a downward-sloping demand curve.
3. Identify the output at minimum average total cost, which is the quantity where the ATC curve reaches its lowest point. This is found by setting the derivative of ATC with respect to quantity equal to zero and solving for quantity.
4. Determine the firm's actual output, which is the quantity where marginal revenue (MR) equals marginal cost (MC), since profit maximization occurs at MR = MC.
5. Calculate the excess capacity as the difference between the output at minimum ATC and the actual output: Excess Capacity = Quantity at minimum ATC - Actual quantity produced.