How to Calculate Excess Capacity
Excess capacity equals the output that minimizes average total cost minus the output the firm actually produces, so any positive gap means the firm sits below efficient scale.
The Excess Capacity formula
Calculator
Enter the firm's output and the output that minimizes ATC to get excess capacity, utilization and the cost penalty.
The quantity where marginal revenue equals marginal cost.
Cost per unit read off the ATC curve at the quantity above.
Efficient scale, the quantity at the bottom of the ATC curve.
The lowest cost per unit the firm's cost curve can reach.
The firm is 200 units away from the output that would minimize its cost per unit.
- Capacity utilization
- 75%
- Unused share of efficient scale
- 25%
- Extra cost per unit
- $2
- Extra cost at current output
- $1,200
- Verdict
- Excess capacity
Current output is 75% of efficient scale.
25% of the low-cost scale goes unused, which is the same gap read as a percentage.
Sitting off the bottom of the ATC curve costs $2 on every unit produced.
Across the units it does make, the firm spends $1,200 more than it would at efficient scale.
Output below minimum-ATC output is excess capacity, the standard result for a monopolistically competitive firm in long-run equilibrium.
How to calculate Excess Capacity, step by step
- 1Find the efficient scale. Efficient scale is the output at the bottom of the U-shaped average total cost curve, the quantity where cost per unit is at its lowest.
- 2Find what the firm actually produces. The firm produces where marginal revenue equals marginal cost. For a monopolistically competitive firm in long-run equilibrium, that quantity sits where the demand curve is tangent to ATC.
- 3Subtract the two quantities. Excess capacity = efficient-scale output − actual output. A positive answer is the unused capacity the firm is carrying.
- 4Turn the gap into a rate. Capacity utilization = actual output ÷ efficient-scale output × 100, which reads as the share of the low-cost scale the firm is using.
- 5Price the gap. Compare average total cost at the actual output with the minimum average total cost. The difference is what each unit costs extra because the firm never reaches efficient scale.
Worked example: Excess Capacity
A coffee roaster sells 600 bags a month at an average total cost of $9 a bag, and its ATC curve bottoms out at $7 a bag when it makes 800 bags. Excess capacity = 800 − 600 = 200 bags, so capacity utilization = 600 ÷ 800 × 100 = 75% and the unused share of efficient scale is 200 ÷ 800 × 100 = 25%. Each bag costs 9 − 7 = $2 more than it would at efficient scale, which is 600 × 2 = $1,200 of extra cost a month.
Excess Capacity questions
Why does monopolistic competition leave excess capacity?
Each firm faces a downward-sloping demand curve, so in long-run equilibrium demand is tangent to ATC on the falling part of the curve rather than at its minimum. Entry competes profit away to zero before the firm ever reaches efficient scale.
Does a perfectly competitive firm have excess capacity?
No. Free entry drives the long-run price down to minimum average total cost, so the firm produces exactly at efficient scale and the gap is zero.
Is excess capacity the same as productive inefficiency?
Producing below efficient scale means the firm is not at minimum ATC, which is what productive inefficiency means. Excess capacity is the size of that shortfall measured in units, and what consumers get in exchange is product variety.
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