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By the end of this section, you will be able to:
  • Apply concepts of productive efficiency and allocative efficiency to perfectly competitive markets
  • Compare the model of perfect competition to real-world markets

When profit-maximizing firms in perfectly competitive markets combine with utility-maximizing consumers, something remarkable happens: the resulting quantities of outputs of goods and services demonstrate both productive and allocative efficiency (terms that were first introduced in ( Choice in a World of Scarcity ) .

Productive efficiency means producing without waste, so that the choice is on the production possibility frontier. In the long run in a perfectly competitive market, because of the process of entry and exit, the price in the market is equal to the minimum of the long-run average cost curve. In other words, goods are being produced and sold at the lowest possible average cost.

Allocative efficiency means that among the points on the production possibility frontier, the point that is chosen is socially preferred—at least in a particular and specific sense. In a perfectly competitive market, price will be equal to the marginal cost of production. Think about the price that is paid for a good as a measure of the social benefit received for that good; after all, willingness to pay conveys what the good is worth to a buyer. Then think about the marginal cost of producing the good as representing not just the cost for the firm, but more broadly as the social cost of producing that good. When perfectly competitive firms follow the rule that profits are maximized by producing at the quantity where price is equal to marginal cost, they are thus ensuring that the social benefits received from producing a good are in line with the social costs of production.

To explore what is meant by allocative efficiency    , it is useful to walk through an example. Begin by assuming that the market for wholesale flowers is perfectly competitive, and so P = MC. Now, consider what it would mean if firms in that market produced a lesser quantity of flowers. At a lesser quantity, marginal costs will not yet have increased as much, so that price will exceed marginal cost; that is, P>MC. In that situation, the benefit to society as a whole of producing additional goods, as measured by the willingness of consumers to pay for marginal units of a good, would be higher than the cost of the inputs of labor and physical capital needed to produce the marginal good. In other words, the gains to society as a whole from producing additional marginal units will be greater than the costs.

Conversely, consider what it would mean if, compared to the level of output at the allocatively efficient choice when P = MC, firms produced a greater quantity of flowers. At a greater quantity, marginal costs of production will have increased so that P<MC. In that case, the marginal costs of producing additional flowers is greater than the benefit to society as measured by what people are willing to pay. For society as a whole, since the costs are outstripping the benefits, it will make sense to produce a lower quantity of such goods.

Questions & Answers

marginal cost formula
Nandu Reply
you should differentiate the total cost function in order to get marginal cost function then you can get marginal cost from it
What about total cost
formula of cross elasticity of demand
Theresia Reply
what is ceteris paribus
Priyanka Reply
what is ceteris parabus
Ceteris paribus - Literally, "other things being equal"; usually used in economics to indicate that all variables except the ones specified are assumed not to change.
What is broker
land is natural resources that is made by nature
What is broker
what is land
What is broker
land is natural resources that is made by nature
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amarsyaheed Reply
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am from nigeria@ pilo
what is production possibility frontier
it's a summary of opportunity cost depicted on a curve.
please help me solve this question with the aid of appropriate diagrams explain how each of the following changes will affect the market price and quantity of bread 1. A
Manuela Reply
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Prosper Reply
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Wat d meaning of management
igwe Reply
disaster management cycle
Gogul Reply
cooperate social responsibility
Fedric Wilson Taylor also define management as the act of knowing what to do and seeing that it is done in the best and cheapest way
difference between microeconomics and macroeconomic
Ugyen Reply
microeconomics is the study of individual units, firm and government while macroeconomics is the study of the economic aggregates.
The classical theory of full employment
what is monopoli power
Adzaho Reply
the situation that prevails when economic forces balance so that economic variables neither increase nor decrease
what is equilibrium
what are the important of economic to accounting students with references
salihu Reply
Economics is important because it helps people understand how a variety of factors work with and against each other to control how resources such as labor and capital get used, and how inflation, supply, demand, interest rates and other factors determine how much you pay for goods and services.
explain the steps taken by the government in developing rural market?
Azeem Reply
government provide good road for than
government should provide good agricultural project and it should also provide good road so that the the product that will come out of the farm will be easy transport to the market
farming equipments should be provided to farmers to help them improve in farming
improving the transport systems providing enterpreneur edecation to the mass living in rural zones enforcment of loans and capital for the people rising awareness on the advantages of rural areas
contribution of Adam smith in economics
abel Reply
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what's happening here
I love this book and i need extra Economic book
what is the meaning of function in economics
Effah Reply
Pls, I need more explanation on price Elasticity of Supply
Isaac Reply
Is the degree to the degree of responsiveness of a change in quantity supplied of goods to a change in price
what is production
Okay what is land mobile and land unmobile
And what are the resources in land
the proces of using the services of labor and equipmnt together with other in puts to make goods and services availble
Okay what is land mobile and land unmobile

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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