Question

compare and contrast between production and allocative efficiency between perfect competition and monopoly. please include diagrams in your explanations.

Answer 1

Productive efficiency is the production with full efficiency and zero waste, i.e. the production is on the production possibility frontier. Perfectly competitive firms are able to achieve productive efficiency by producing at the level where market price is equal to lowest level of Average cost. This is achieved in the long run, when zero economic profits are earned due to the entry/exit of firms. On the other hand, monopoly is not able to achieve production efficiency as the production output is below the output of the lowest level of Average cost.

Perfect Competition Monopoly

As per the diagram, we can see that perfect competition is producing at the point where Price = lowest of Average Cost = Marginal cost (Point Y). Monopoly is producing at the point Q where MC = MR, but this is not the point where we have the lowest of Average cost. Thus Price level is a point higher than MC. Thus in absence of economies of scale, monopoly is productively inefficient.

Allocative efficiency, is achieved in the scenario when among points on the production possibility frontier, the production point chosen is socially efficient and preferred. This is achieved in case of perfect competition when production is at the point where P = MC or price is equal to Marginal Cost, as the consumers are getting exactly the amount at their willingness to pay. Whereas, in case of the Monopoly market, Price is above Marginal Cost, leading to the possibility of social gains by producing at a socially preferred point other than point Q as consumer's willingness to pay is lesser. Thus, monopoly is allocatively inefficient.