Overview
This lecture introduces the concepts of efficiency in perfectly competitive markets, focusing on productive and allocative efficiency, and sets up a future comparison with monopolies.
Efficiency in Perfect Competition
- In the long run, perfectly competitive markets achieve both productive and allocative efficiency.
- Productive efficiency means firms produce output at the lowest possible cost, minimizing resource waste.
- Productive efficiency occurs where marginal cost equals minimum average total cost (ATC).
- Allocative efficiency means firms produce the quantity where the benefit to consumers (willingness to pay) equals the cost to society (marginal cost).
- In perfect competition, firms produce as long as price (willingness to pay) exceeds marginal cost, stopping when price equals marginal cost.
Productive Efficiency (Review from Chapter 2)
- Productive efficiency is when firms maximize output with given resources, operating on the production possibility frontier (PPF).
- No resources are wasted; production is at the minimum point of the average total cost curve.
Allocative Efficiency Explained
- Allocative efficiency occurs when every unit produced provides greater benefit to society than cost.
- The market achieves a socially optimal outcome when the price consumers are willing to pay equals marginal cost.
- Unlike monopolies, perfect competition avoids deadweight loss because all beneficial transactions occur.
Key Terms & Definitions
- Productive Efficiency — Producing at the lowest possible cost; output is maximized with given resources.
- Allocative Efficiency — Producing the quantity where consumer willingness to pay equals the marginal cost, ensuring optimal societal benefit.
- Deadweight Loss — Loss of total surplus that occurs when the market does not produce at allocative efficiency.
Action Items / Next Steps
- Review definitions of productive and allocative efficiency.
- Prepare to compare perfect competition with monopoly in the next chapter.