Question

Discuss in detail how perfectly competitive prices bring about allocative efficiency

(Answer this question for 10 marks)

Answer 1

It is important for a firm to produce the right kind of goods i.e. to produce goods that customers value the most. Many a times it happens that firm produce goods by efficiently making use of resources but they are not producing the goods that customer value the most. Perfectly competitive prices helps to bring about allocative efficiency because a perfectly competitive firm sets its price equal to its marginal cost. which represents the opportunity cost of resources that is used to produce the last unit sold.

The demand curve for a perfectly competitive firm indicates the marginal benefit that consumers attach to each unit of a good and the market price reflects the amount that people are ready to pay for the final unit . Thus the demand and supply curves for a perfectly competitive firm intersect at a point where marginal benefit equals marginal cost. As long as the marginal cost which is also the price equals the marginal benefit we could say that the firm is producing what the customers want and therefore the market is considered as allocatively efficient.