Question

Many industries are often plagued by overcapacity: Firms simultaneously invest in capacity expansion, so that total capacity far exceeds demand. This happens not only in industries in which demand is highly volatile and unpredictable, but also in industries in which demand is fairly stable. What factors lead to overcapacity? Explain each briefly.

Short answer

Overcapacity in industries, be it with volatile or stable demand, can occur due to factors such as fluctuation in demand, technological change, competition, inaccurate forecasting and regulatory changes.

Step-by-step solution

Understanding Overcapacity

Overcapacity is a situation where the supply of goods exceeds demand. In industries, this situation can occur due to various reasons, regardless of whether the industry has a volatile or stable demand situation.

Factors Leading To Overcapacity In Volatile Demand Industries

For industries with volatile and unpredictable demand, the factors leading to overcapacity could be: \n1. Fluctuating demand: Since demand is unpredictable, firms may overshoot their capacity to prepare for peak demand periods, resulting in overcapacity in lower demand periods. \n2. Technological change: Rapid advancements in technology may render present capacity obsolete, leading to overcapacity.

Factors Leading To Overcapacity In Stable Demand Industries

Even in industries with stable demand, overcapacity can occur due to reasons such as: \n1. Competition: To gain a larger market share, a firm may expand its capacity, causing others to do the same leading to overall overcapacity. \n2. Inaccurate forecasting: Firms could overestimate future demand, leading to unnecessary expansion of capacity. \n3. Regulatory changes: Sometimes changes in regulations or policies can lead to overcapacity. For example, if a policy reduces the cost of increasing capacity, firms may over-invest.