What does excess capacity refer to in a firm?

Excess capacity refers to a situation where a firm produces at a lower output level than what its design capacity allows. This condition indicates that the firm's facilities, equipment, and workforce can support a higher level of production than what is currently being utilized. As a result, there is unused potential within the company, meaning that resources are not being fully exploited to meet market demand.

This concept is crucial for understanding operational efficiency; when a company operates below its capacity, it may not be maximizing profits or fully serving its customers. Identifying and addressing excess capacity can help firms improve their productivity and operational strategies to align better with market needs.