Excess capacity under monopolistic competition:

Consider the long-run equilibrium for the firm under monopolistic competition. At the equilibrium, the perceived demand curve is tangent to the LRAC curve. Since the demand curve is downward sloping, the LRAC is also downward sloping at this point. Unlike in perfect competition, the firm's equilibrium would never be at the minimum point of the LRAC curve. Hence,
it is argued that the firm's output under monopolistic competition is not the ideal output and there exists excess capacity, which is a wasteful use of society's resources.  

Ideal output or the optimum output is associated with the minimum point of the LRAC curve. The excess capacity is the difference between the optimal output and the actual output attained by the firm in the long-run. As Cassels argues, excess capacity in monopolistic competition could be divided into two components. This is shown in figure:

OX₁: Ideal or optimal output as it corresponds to minimum point of LRAC curve

OX_E: Long-run equilibrium output in a monopolistic competitive market

SRAC₁: Short-run average cost curve corresponding to optimal plant for output OXE

SRAC₂: Short-run average cost curve corresponding optimal plant for output OX1

Excess capacity is X_E X₁, which could be decomposed as

i) X_M X₁: due to not building the technically optimal plant
ii) X_EX_M: due to not operating the plant at the minimum point of the average cost

Chamberlin, however, defended the high cost of output under monopolistic competition with the shield of the product differentiation. According to him, people may be willing to pay for the differentiation. Thus, the ideal output is not that one corresponding to the minimum point of the LRAC curve. Of course, excessive proliferation of products of different quality is a waste of society's resources, but the cost of monotonicity produced by having uniform products has to be taken into account as well.