Theories of Chamberlin’s monopolistic competition and Joan Robinson’s imperfect competition have revealed that a firm under monopolistic competition or imperfect competition in long run equilibrium produces an output which is less than socially optimum or ideal output. This means that firms operate at the point on the failing portion of long run average cost curve, that is, they do not produce the level of output at which long run average cost is minimum. Long run equilibrium of a firm under monopolistic competition is achieved when the demand curve facing a firm becomes tangential to the long run average cost curve so that it earns only normal profits. Under such circumstances a firm can reduce average cost by expanding output to the minimum level of long run average cost, but it will not do so because its profits are maximized at the level of output smaller than at which its long run average cost is minimum.
Society’s productive resources are fully utilized when they are used to produce the level of output which renders long run average cost minimum. Thus a monopolistically competitive firm produces less than the socially optimum or ideal output, that is, the output corresponding to the slowest point of long run average cost curve. This is in sharp contrast to the position of the firm in long run equilibrium under perfect competition, which operates at the minimum point of the long run average cost curve. The amount by which the actual long run output of the firm under monopolistic competition falls short of the socially ideal output is a measure of excess capacity which means unutilized capacity.
Long run equilibrium of a firm under monopolistic competition is achieved when the demand curve facing a firm becomes tangential to the long run average cost curve so that it earns only normal profits. Under such circumstances a firm can reduce average cost by expanding output to the minimum level of long run average cost, but it will not do so because its profits are maximized at the level of output smaller than at which its long run average cost is minimum. Therefore, the firm is producing MN less than the ideal output. Thus MN output represents the excess capacity refers only to the long run. This is because in the short run under any type of market structure (including perfect competition) there can be all sorts of departments from the ideal reflecting incomplete adjustment to the existing market conditions.