Market Imperfection and Excess Capacity

OF all the doctrines emerging from recent work on the economics of imperfect competition, none appears more intellectually striking or more significant from a practical point of view than the doctrine of excess capacity. It is intellectually striking, because it admits possibilities which the traditional laws of economics seem to have excluded: e.g. that an increase in supply may be followed by a rise in price.' And it is practically significant, because if the main contentions of the theory are found to be correct, it affords some reasons for interfering with the free play of comnpetitive forces on grounds upon which traditional economic theory would have dismissed the case for interference. The theory envisages a situation, where, on the one hand the market facing a group of competing firms is, for one reason or another, not absolutely perfect, while on the other hand the entry of resources into the industry is free, and it shows that under such conditions competition (i.e. the free flow of resources into uses where they expect to obtain the largest net remuneration) will drive each producer to a situation in which it is not using its resources to the best advantage; and it will thus lead to a reduction of the physical productivity of resources all round. In a sense, it thus reverses the old argument about increasing returns and monopoly; it not only says that falling costs will lead to monopoly but that a monopolistic or rather a pseudo-monopolistic situation2 will automatically lead each firm to a position where it is faced with