Question

Please describe which one of the market models best utilizes the concept of productive and allocative efficiencies. What would be the main characteristic?

Answer 1

Ans -: Productive Efficiency takes place when the equilibrium output is supplied at the minimum average cost without any wastage.

Allocative Efficiency occurs when the distribution is socially desirable and there is no dead weight loss i.e. there is no excess burden on the society.

• These features are fulfilled only in Perfect Competition.
• In the long run , there is free entry and exit of the firms in the Perfect Competition and due to this process the market price is equal to the minimum point of long run average cost curve . This means that the goods are being produced at the lowest cost possible without any wastage . The capacity of the firm is fully utilised so , we can say that Perfect Competition is Productively efficient in the long run.
• In Perfect Competition , the prices are equal to Marginal cost which implies that the benefit received by consumers as well as the firms are equal . It means that no firm exercises monopoly power and hence there is just distribution of goods . The cost to society is zero here and there is no dead weight loss. It implies that the Perfect Competition market is Allocatively Efficient.

Thus, Perfect Competition market is productively efficient as well as allocatively efficient . To summarise the characteristic we can say :

A. Allocative efficiency -:

1. In both short run and long run , the prices in perfect competition is equal to marginal cost (P=MC) .
2. At this equilibrium price , both consumer and producer surplus are maximised.
3. There is Pareto Efficiency/allocative efficiency in perfect competition .
4. There is no dead weight loss and no monopoly power in the market.

B. Productive Efficiency -:

1. In the long run , firms earn normal profits and the production is maid at the minimum efficient scale i.e. minimum point of Long run average cost curve.

Hence , Perfect Competition possess the quality of an efficient market (productive+allocative) . However , it is a hypothetical market and does not exist in real life situations.