Production and Allocative Efficiency
This section looks at the main difference between productive efficiency and allocative efficiency.
Productive Efficiency
- For the firm, productive efficiency is producing on it’s LRATC (Long Run Average Total Cost), which is at the lowest cost for each output
- For the industry cost to be minimized, marginal cost (MC) must be equal for every firm. Just because each firm is being efficient does not mean the whole industry is producing at minimum cost. Example: Marginal cost for firm A is $30 and for firm B is $40. If B makes one less book and A makes one more book, the output would be the same but the industry saves $10.
Allocative Efficiency
- A market has allocative efficiency when the Price (Marginal Value/Benefit) = MC
- When the market has allocative efficiency the total surplus (Consumer Surplus + Producer Surplus) is maximized.
- In the diagram below, allocative efficiency occurs where demand intersects with the marginal cost, which occurs at an output of ________and price of ________.
- Anywhere on the left of 20 the marginal value is ________ than marginal cost so ________ units should be produced and consumed.
- Anywhere on the right of 20 the marginal value is ________ than marginal cost so ________ units should be produced and consumed
Efficiency in Different Types of Markets
Perfect Competition
Perfect competition is productively efficient because each firm has the same MC. It’s also allocatively efficient because Price = MC
Monopoly
- Monopoly is productively efficient (no other firm in the market so industry has the same MC). It does not have allocative efficiency because P > MC.
- The only exception to this rule is a monopoly with perfect price discrimination that will charge every consumer the maximum that they are willing to pay. In this case allocative efficiency will be achieved because they will produce till the point where Price = MC.
Oligopoly and Monopolistic Competition Oligopoly and monopolistic competition do not have productive or allocative efficiency because each firm does not necessarily have the same MC and they produce where Price > MC.
Example: Production and Allocative Efficiency
If MC is P = 100 + Q and the demand curve is P = 200 – Q, what is the allocatively efficient price and output level for this industry?
A) 150, 50 B) 50, 150 C) 100, 50 D) 50, 100
A.
Allocative efficiency is when Price (Demand) = MC which is at the equilibrium level:
200 - Q = 100 + Q
2Q = 100
Q = 50
P = 200 - 50 = 150
Example: Efficiency with Different Market Structures
What type of market structure is this industry if it produces at the level of output from the previous question?
A) Monopoly
B) Monopolistic competition
C) Perfect competition
D) Oligopoly
C.
Only in perfect competition do they achieve allocative efficiency. The only exception to this rule is if they had said a monopoly that uses perfect price discrimination (then that would be correct also).