Final answer:
Monopolistic competition is defined by excess capacity because firms produce below the least-cost output due to product differentiation and lack of productive efficiency. This results in prices higher than marginal costs and underutilization of capacity.
Step-by-step explanation:
Monopolistic Competition and Excess Capacity
Monopolistic competition is characterized by excess capacity because firms produce at a level where their output is less than the least-cost output, which is not productively efficient. Unlike in perfect competition where firms produce goods at the lowest average cost, monopolistic competition results in firms operating on the downward-sloping portion of the average cost curve. This happens because monopolistic competitors differentiate their products and do not sell at the price that correlates with the lowest point on the average cost curve. Additionally, markets with monopolistic competition typically have inefficiencies due to prices exceeding marginal costs and operating with an excess capacity, which is the underutilization of a firm's productive capacity.
Differentiated products play a significant role in monopolistic competition by allowing firms to develop a degree of market power, leading to the ability to charge prices greater than marginal costs and to operate with excess capacity. High barriers to entry are another characteristic of imperfectly competitive markets such as oligopolies, where a handful of firms hold significant market share and can influence market outcomes strategically.