Question

Explain how a perfectly competitive market promotes productive efficiency (minimum average costs).

Answer 1

In perfect competition, market prices reflect complete mobility of resources and freedom of entry and exit, full access to information by all participants, homogeneous products, and the fact that no one buyer or seller, or group of buyers or sellers, has any advantage over another.

Productive efficiency means producing without waste so that the choice is on the production possibility frontier. In the long run in a perfectly competitive market because of the process of entry and exit.the price in the market is equal to the minimum of the long-run average cost curve. In other words, goods are being produced and sold at the lowest possible average cost.

The concept is illustrated on a production possibility frontier (PPF) where all points on the curve are points of maximum productive efficiency (i.e., no more output can be achieved from the given inputs).

An equilibrium may be productively efficient without being allocatively efficient. In other words, just because a market maximizes the output it generates, that doesn’t mean that social welfare is maximized.

In long-run equilibrium for perfectly competitive markets, productive efficiency occurs at the base of the average total cost curve, or where marginal cost equals average total cost.

(Image copied from third party for easy understanding)