Question

State the condition (in terms of costs and revenues) that describes allocative efficiency that occurs in LR equilibrium and explain what happens to Producer Surplus in this case.

Answer 1

When the resource allocation becomes efficient the wastage of resources is minimized and the market is called to have attained allocative efficiency. It implies that the price is equal to the marginal cost of production and it indicates that the market price determined by the market supply and demand forces is equal to the opportunity cost of producing the equilibrium quantity. Therefore the desired condition is that the price should be equal to the marginal cost. Both the producer surplus and the consumer surplus are maximized the when there is allocative efficiency.