Monopolistic competition is characterized by excess capacity because:

• A. firms are price takers in the long run
• B. firms face perfectly elastic demand curves
• C. firms produce at a level of output where average total cost is not minimized
• D. there are significant barriers to entry in the market

Answer: (C)

Verified step by step guidance

1. Understand the concept of excess capacity in monopolistic competition: it means firms do not produce at the minimum point of their average total cost (ATC) curve, leading to underutilized resources.
2. Recall that in monopolistic competition, firms have some market power and face downward-sloping demand curves, unlike perfect competition where firms are price takers with perfectly elastic demand.
3. Recognize that in the long run, firms in monopolistic competition produce where marginal cost (MC) equals marginal revenue (MR), but this output level is less than the output that minimizes average total cost (ATC).
4. Note that because firms do not produce at the minimum ATC, they have excess capacity, meaning they could increase output and lower average costs but do not due to the downward-sloping demand curve and market power.
5. Conclude that the correct explanation for excess capacity is that firms produce at a level of output where average total cost is not minimized, rather than due to price-taking behavior, perfectly elastic demand, or barriers to entry.