In Chamberlin’s alternative approach, why does the excess capacity of a monopolistically competitive firm emerge ?
Absence of active price competition despite free entry and exit
Absence of active price competition despite free entry and exit option is correct.
Chamberlin’s theory of monopolistic competition shows each firm facing a downward-sloping perceived demand curve (dd) because its product is differentiated. Long-run equilibrium arrives when free entry drives the firm’s dd curve to tangency with its long-run average cost curve, at a point to the left of minimum LAC.
Because the tangency point is on the falling portion of LAC, output falls short of the least-cost scale — hence the well-known “excess capacity” result. The gap arises precisely because price competition is muted: differentiation lets firms attract customers through non-price means, so entry keeps eroding profits by shifting demand rather than by driving price down to min LAC.
Active price competition alone would push the tangency toward the horizontal segment of LAC and eliminate the excess capacity; free entry and exit without differentiation would replicate the perfectly competitive outcome. The joint feature that produces excess capacity is entry combined with the absence of active price competition.
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