3.4.1 Efficiency Flashcards
What is Allocative efficiency?
When resources are allocated in a way that consumers and producers recieve the maxmium possible benefit.
No one can be made better off without making some else worse off.
There is no excess demand or supply.
Where does allocatively efficient occur at?
AR = MC
What people want (price / AR) = What it costs to make it (MC)
Are firms likely to be allocatively efficient?
No, because allocative efficiency (where price = marginal cost) means the firm cannot charge more than it costs to produce, so they earn no supernormal profit. Most firms aim to set prices above marginal cost to maximise profit, making them allocatively inefficient.
What is productive efficiency?
There is no wastage of scarce resources and there is a high level of factor productivity. At this point, average costs are minimised.
A firm is productively efficient when it is producing goods at the lowest possible cost per unit.
In other words:
It’s when the firm is making stuff without wasting any resources.
Where does productive efficiency occur at?
Occurs where MC = AC
This is because the AC curve is essentially the cost curve and if your marginal cost is producing at the bottom of it, it means the average can’t be lower and each good is being produced at the bottom of the average cost.
MC = AC where AC is intercepted by MC at its lowest point.
What is dynamic efficiency?
Dynamic efficiency is about improving over time — it’s when a firm innovates, invests, and improves its products or production methods in the long run by reinvesting its profits.
It lowers both short run and long run ATC.
Why might firms not be dynamically efficient?
- If there’s no competition, they might just sit back and enjoy profits (like monopolies)
- If they’re under pressure to cut costs short-term, they won’t invest in long-term improvements
What is X - Inefficiency?
Occurs when a firm lacks the incentive to control production costs.
The ATC is higher than it should be.
It often occurs when their is a lack of competition or a moral hazard.
What are the usual characterstics of different market structures?
- The number of buyers
- The number and size of firms. The market’s concentration ratio
- The type of product in the market (homogenous or differentiated)
- The types of barriers to entry and exit
- The degree of competition
What 2 categories can market structures be seperated into?
Perfect Competition
Imperfect Competition
What is perfect competition?
A market structure in which no firms have individual market power due to the amount of competition and are therefore unable to influence price.
What is imperfect competition?
Where firms do have some market power and can influence prices.
Like Monpolistic, Oligpoly or Monpoly.
What does a perfect competition diagram look like with regards to efficiency / inefficiency IN THE LONG RUN (Normal Profits)
Perfectly competitive market diagram observations
The firm produces at the profit maximisation level of output, where MC=MR (Y)
The firm is productively efficient as MC=AC at this level of output
The firm is allocatively efficient as AR (P)=MC
The firm is unlikely to experience dynamic efficiency as it is unlikely to have supernormal profits to reinvest
What does an imperfect competition diagram look like with regards to efficiency / inefficiency?
The firm produces at the profit maximisation level of output, where MC=MR (A)
The firm is not productively efficient as AC > MC at this level of output (B-A)
Productive efficiency would occur at point E, where MC=AC
The firm is not allocatively efficient as AR (P) > MC at this level of output (D-A)
Allocative efficiency would occur where AR=MC
The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation
