Question

1. Using diagrams, illustrate how the price (P) and the demand (d) for a perfectly-competitive firm are determined.

2. Using a diagram, show how the perfectly-competitive firm determines its profit-maximizing output.

3. Differentiate between productive efficiency and allocative efficiency.

Answer 1

Ans) a) Perfectly competitive market is where there are many sellers selling homogeneous products. Firms are price takers and price is decided by forces of demand and supply. This price is equal to marginal revenue for an individual firm and also acts as its demand curve. (P=MR=D)

b) A profit maximising firm produces the quantity where MR and MC curve intersect. If price is above ATC, firms earn positive economic profit. If price is equal to ATC, firms earn zero economic profit. If price is below ATC, firms earn negative economic profit. But firm will continue to produce in short run if price is above AVC and will shutdown if price is below AVC.

c) Allocative efficiency is when the resources used for making the goods and services are allocated in such a way that they are most desired by the society. It occurs where price is equal to marginal cost (P=MC).

Productive efficiency is when least costly techniques are used for producing desirable goods and services. It happens when P = min of ATC (see in zero economic profit graph, where Price is equal to min of ATC)