Question

2.“As monopolistic competition lead to excess capacity, there will be an unambiguous social gain if government regulation reduces the number of firms and eliminates excess capacity.”

a.What is meant by excess capacity?

b. Demonstrate (on a graph) that monopolistic competition leads to excess capacity.

c. Do you agree or disagree with the statement’s policy recommendation? Why? Explain?

Answer 1

a)

Excess capacity refers to production capacity of firm which is not utilized. Firm must operates at the minimum point of AC to reach efficient level or where firm does not have excess capacity.

b)

Following is diagram:

In above diagram, firm operates at the fall point of AC curve or firm does not operate where AC cuts the MC.

Thus, there is excess capacity in such market.

c)

Generally, it is said that there must be government intervention to produce at the efficient level of output or firm must operate at level that corresponds to the minimum level of AC.

Although such regulation will increase output level of single firm, but if number of firm is reduced, consumer would face or will have few varieties. Monopolistic firms produce differentiated products and consumers are ready to pay higher price for quality and customized products. Thus, intervention of government will curtail welfare of people. Now they will be made to select from few available goods.