In perfectly competitive markets we have productive efficiency as output is produced at the lowest cost in the long run. This is because the demand curve (also the average and marginal revenue curve) for the firm is perfectly horizontal and is tangential to the minimum point of the average cost curve. There is zero economic profit at this point.
Perfectly competitive markets are also efficient in allocating resources. This is because price that people are willing to pay (represented by the demand curve) is equal to marginal cost of production. If MC > P then it is better if resources are shifted away from the current use to producing goods where the price that people are willing to pay (relecting their value for the product) is equal to the marginal cost of producing it. In perfectly competitive markets MC=P and hence there is allocative efficiency. Allocative efficiency , unlike productive efficiency , can occur in the short run as well.
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Product efficiency is achieved when goods and services are produced with the lowest possible cost making it exist when production lies at lowest point of the lowest average cost curve. Production in perfect competition occurs at the lowest point of the average cost curve as the marginal revenue and marginal cost curve in the long run intersect at the lowest point of the average cost curve. This condition is well met in perfectly competitive market as in the long run all firms can only make normal profit.
ReplyDeleteAllocative efficiency is achieved when products that are most wanted are produced. It exists when price is equals to marginal cost of production. This means the price paid by the customer will represent the true economic cost of producing the last unit of product. This condition will exist even in short run. Producers in aim to maximize profit will produce at the point where Marginal Cost equals Marginal Revenue. And in a Perfectly Competitive Market the Marginal Revenue Curve and the Demand Curve are the same. Which means Price (average revenue) will be equal to Marginal Revenue. Thus regardless of short or long run or of whether a firm makes loss or profit exist allocative efficiency is always achieved in Perfectively Competitive Market.
However in real life where non perfect competition exists, productive efficiency is more likely to be achieved than allocative efficiency.
-Sachi Poudyal
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