Perfect Competition and Efficiency - Online Tutor, Practice Problems & Exam Prep

In perfectly competitive markets, both productive efficiency and allocative efficiency are achieved. Productive efficiency occurs when firms produce at the lowest possible cost, where price equals average total cost (ATC). Allocative efficiency is reached when the marginal benefit to consumers equals the marginal cost to producers, ensuring that resources are allocated according to consumer preferences. This equilibrium leads to an efficient market outcome, contrasting with other market structures that typically fail to achieve these efficiencies.

Efficiency in Perfect Competition

Alright, now let's discuss productive efficiency and allocative efficiency in perfectly competitive markets. So what we're going to see is that in perfect competition, we achieve both productive efficiency and allocative efficiency. Cool? So hooray, we're going to get our efficient quantities here. So let's start with productive efficiency. How is a perfectly competitive market productively efficient? So remember that productive efficiency is producing at the lowest possible cost, okay? Lowest possible cost and the lowest possible cost is the minimum of our ATC, right? The lowest that our average total cost goes, that is the lowest cost, right? So when we talk about productive efficiency, we can think about price equaling average total cost, okay? So that is a condition of our productive efficiency. We're able to produce at the lowest possible cost, okay? And what have we seen? When we've been discussing the long run of perfect competition, we see that the firms are producing at the minimum of ATC. Whoops. My spelling's all over the place. Minimum of the ATC, right? So we are being productively efficient just like we see on this graph, just like we've been talking about in the long run, right? That that price is going to touch right at the minimum of the ATC, right? So we are going to be productively efficient, okay? So they're going to be producing this quantity at this price and that is being produced at the lowest possible cost, so perfect competition forces companies to be as efficient as possible, right? To try and lower their cost as much as possible to make profits. Okay, so we're going to see that we are at the minimum of our ATC when we are in our equilibrium there so we are being productively efficient. Cool?

Let's go on down here to Allocative Efficiency. So remember Allocative Efficiency has to do with consumer preferences, right? Production represents consumer preferences. Okay? So what this means when we start thinking in terms of economic terms, this really means that we're producing up to the point where the marginal benefit equals the marginal cost, right? And when I talk about marginal benefit, we're not talking about the marginal benefit to the producers anymore, right? We're talking about the marginal benefit to the consumers, right, so that marginal benefit to the consumers is going to equal the marginal cost to the producers, right? So only when these are equal are we reaching allocative efficiency, so that's what's going to go in here. Marginal benefit equals marginal cost, that's kind of our condition for allocative efficiency. So let's go into this box here where I'll discuss how we reach allocative efficiency. So first let's start with the idea of the marginal benefit to consumers. So the price of the good represents the last unit sold, right? The marginal benefit of the last unit sold, right? If you think about it, we're selling units to all these people who have a higher willingness to pay, right? We have that downward sloping demand curve. I guess I'll draw it in here just to reiterate. So we've got this downward sloping demand curve, right, And then so that's demand and we've got our supply going up, right? If this is our price right here, well there was somebody way up here who was willing to pay way more than that price, right? This is our equilibrium price but there's all these people on the way down that are willing to pay more than that price until we get to that last person. That last person is willing to pay exactly the price on the market, right? So that's the marginal benefit to the last person, right? When we think of them making a purchase, they're purchasing it because that's the benefit that they get, right? So that last person's benefit is going to be the value of the good, right at the price. So that last unit, the marginal benefit equals the price just like we see here. And now let's think of the other side, the marginal cost side. So in perfect competition, as we've been seeing, the firms are producing where marginal revenue equals marginal cost, right? Our marginal revenue equals our marginal cost, that's the profit maximizing point and we've been doing that all throughout these lessons, right? Marginal revenue equals marginal cost to the firm and well, what did we see in perfect competition? The firm, right let me draw another little graph over here. The firm had the price on the market that they had to sell at, right? This was the price on the market and that was the demand curve that they face, right? Because they can you know let me get out of the way, they can produce any amount and it'll be sold at that price and then there's going to be their marginal cost curve, Right? They're going to have some sort of marginal cost curve here. Whatever it might look like, and this is their price. So right here is the price equals the average revenue equals the marginal revenue to the firm, right? And they're going to produce right there where the price equals marginal cost, right? So the price equals marginal cost, the price equals marginal benefit, well guess what? We can equate the 2 since the firms are producing to the point where the marginal benefit to consumers equals the marginal cost to producers and that's this last one here, right? The price equals marginal benefit, the price equals marginal cost, so there we go we reach productive efficiency, they both equal each other. Marginal benefit to the consumer is equal to the marginal cost to the producer. So there we go, we've reached productive efficiency and allocative efficiency in perfect competition. Unfortunately, our other market structures are not going to achieve productive nor allocative efficiency, okay? So this is a very specific case for perfect competition. Now there is one situation with a monopoly that we will see that an efficiency can be reached, but that's neither here nor there. This is the main key point is that in perfect competition we do get both productive and allocative efficiency. Cool? Alright, so let's go ahead and move on to the next video.

The firm is a price taker because: 

• A. It has a U-shaped ATC curve
• B. The profit-maximizing point occurs where MC equals ATC
• C. The MC curve has an upward slope
• D. The MR curve is horizonta

When this firm is producing the profit-maximizing output: 

• A. Total revenue is equal to total cost
• B. It earns an economic profit
• C. Only allocative efficiency is reached (i.e. no productive efficiency)
• D. Only productive efficiency is reached (i.e. no allocative efficiency)

When P = MC = minimum ATC for individual firms, in the entire market:

• A. Consumer surplus is larger than producer surplus
• B. Producer surplus is larger than consumer surplus
• C. Supply and demand are the same
• D. Total surplus is at a maximum

Here’s what students ask on this topic:

What is productive efficiency in a perfectly competitive market?

Productive efficiency in a perfectly competitive market occurs when firms produce goods at the lowest possible cost. This is achieved when the price equals the average total cost (ATC) at its minimum point. In mathematical terms, this can be expressed as:

$P=\mathrm{ATC}|\min$

In the long run, firms in a perfectly competitive market adjust their production to ensure they are operating at this minimum ATC, thereby achieving productive efficiency. This means that resources are being used in the most cost-effective way, minimizing waste and maximizing output.

How is allocative efficiency achieved in a perfectly competitive market?

Allocative efficiency in a perfectly competitive market is achieved when the marginal benefit to consumers equals the marginal cost to producers. This ensures that resources are allocated according to consumer preferences. In mathematical terms, this can be expressed as:

$\mathrm{MB}=\mathrm{MC}$

Here, $\mathrm{MB}$ represents the marginal benefit to consumers, and $\mathrm{MC}$ represents the marginal cost to producers. This equilibrium ensures that the quantity of goods produced matches consumer demand, leading to an efficient market outcome.

Why do perfectly competitive markets achieve both productive and allocative efficiency?

Perfectly competitive markets achieve both productive and allocative efficiency due to the nature of competition and market equilibrium. Productive efficiency is achieved because firms produce at the lowest possible cost, where price equals the minimum average total cost (ATC). Allocative efficiency is achieved because the price consumers are willing to pay (marginal benefit) equals the marginal cost of production. This dual efficiency ensures that resources are used optimally, minimizing waste and aligning production with consumer preferences. Other market structures, such as monopolies, often fail to achieve these efficiencies due to lack of competition and price-setting power.

What is the difference between productive efficiency and allocative efficiency?

Productive efficiency and allocative efficiency are two distinct concepts in economics. Productive efficiency occurs when goods are produced at the lowest possible cost, which happens when firms operate at the minimum point of their average total cost (ATC). In contrast, allocative efficiency is achieved when the production of goods matches consumer preferences, meaning the marginal benefit to consumers equals the marginal cost of production. In mathematical terms:

Productive Efficiency: $P=\mathrm{ATC}|\min$

Allocative Efficiency: $\mathrm{MB}=\mathrm{MC}$

While productive efficiency focuses on cost minimization, allocative efficiency ensures that resources are distributed according to consumer demand.

Can other market structures achieve productive and allocative efficiency?

Other market structures, such as monopolies and oligopolies, typically do not achieve both productive and allocative efficiency. In monopolies, the lack of competition allows the firm to set prices above marginal cost, leading to allocative inefficiency. Additionally, monopolies may not produce at the lowest possible cost, resulting in productive inefficiency. Oligopolies, with few firms dominating the market, may also fail to achieve these efficiencies due to strategic interactions and potential collusion. Perfect competition is unique in that it forces firms to produce at the lowest cost and align production with consumer preferences, achieving both productive and allocative efficiency.