Efficiency of Perfect Competition

Question 1

What is allocative efficiency?

Answer 1

Allocative efficiency is producing the combination of goods and services that consumers mostly want; occurs when P (MB) = MC

• if P > MC, an additional unit is worth more to consumer than it costs to produce (under allocation)
• if P < MC, an additional unit is worth less to consumers than it costs to produce (over allocation)

At MB=MC, social welfare is maximized.

Question 2

What is productive efficiency?

Answer 2

Productive efficiency occurs when production takes place at the lowest possible cost (P = minimum ATC)

Question 3

Is a firm in perfect competition allocatively efficient?

Answer 3

Yes it is. The firm will produce at MR = MC (profit-maximizing level) and since MR = P = MB, firm will produce at MB = MC (allocatively efficient output).

Question 4

Is a firm in perfect competition productively efficient?

Answer 4

A perfectly competitive firm is productively efficient only in the long run. This is because in the long run, a firm’s equilibrium earns normal profit (P = minimum ATC). However, in the short run, a firm will not be productively efficient if its not earning normal profits.