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Chapter 8: Problem 9

Productive efficiency and allocative efficiency are two concepts achieved in the long run in a perfectly competitive market. These are the two reasons why we call them "perfect." How would you use these two concepts to analyze other market structures and label them "imperfect?"

Short Answer

Expert verified
In a perfectly competitive market, firms achieve productive efficiency by producing at the lowest possible cost and allocative efficiency by allocating resources to maximize consumer and producer surplus. In contrast, "imperfect" market structures like monopolies may not achieve productive efficiency due to less incentive to minimize costs and fail to achieve allocative efficiency as the price charged is higher than the marginal cost of production, resulting in deadweight loss. Thus, imperfect market structures lead to suboptimal allocation of resources and decreased economic welfare compared to perfectly competitive markets.

Step by step solution

01

Understand Productive Efficiency

Productive efficiency occurs in a market when firms produce at the lowest possible cost. This is achieved at the minimum point of the average total cost curve, where the firm can produce the maximum number of products at the lowest cost per product. In a perfectly competitive market, firms achieve productive efficiency in the long run because each firm is a price taker and is driven to minimize costs to survive.
02

Understand Allocative Efficiency

Allocative efficiency occurs when resources are allocated in a way that maximizes consumer and producer surplus. In a perfectly competitive market, this is achieved because the market price equals the marginal cost of production (P = MC); hence, resources are allocated to produce the goods that consumers value the most. This results in a balance between consumer preferences and the production cost, maximizing overall economic welfare.
03

Compare Perfectly Competitive Markets and Monopolies

To analyze other market structures, consider a monopoly as an example of an "imperfect" market. In a monopoly, there is only one firm controlling the entire market, which leads to different outcomes in terms of efficiency.
04

Analyzing Productive Efficiency in Monopolies

In a monopoly, the firm can set the price and quantity levels. This means that monopolists have less incentive to minimize their costs compared to a firm in a perfectly competitive market. Thus, the monopolist may not achieve productive efficiency because they are not as focused on minimizing costs as their perfectly competitive counterparts.
05

Analyzing Allocative Efficiency in Monopolies

Allocative efficiency is also not achieved in a monopoly because the price charged is higher than the marginal cost of production (P > MC). This results in a deadweight loss, which represents the decrease in economic welfare due to underproduction of the good. Consequently, resources are not allocated optimally, and consumers may not have access to the goods they desire at a price that reflects their preferences.
06

Conclusion

Through the comparison of a perfectly competitive market and a monopoly, we can analyze how other market structures can be considered "imperfect." When a market structure fails to achieve productive efficiency and/or allocative efficiency, resources are not allocated optimally, and economic welfare is not maximized. Therefore, such market structures can be labeled as "imperfect" compared to the "perfect" nature of competitive markets.

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Most popular questions from this chapter

Perfectly competitive firm Doggies Paradise Inc. sells winter coats for dogs. Dog coats sell for \(\$ 72\) each. The fixed costs of production are \(\$ 100 .\) The total variable costs are \(\$ 64\) for one unit, \(\$ 84\) for two units, \(\$ 114\) for three units, \(\$ 184\) for four units, and \(\$ 270\) for five units. In the form of a table, calculate total revenue, marginal revenue, total cost and marginal cost for each output level (one to five units). On one diagram, sketch the total revenue and total cost curves. On another diagram, sketch the marginal revenue and marginal cost curves. What is the profit maximizing quantity?

Assuming that the market for cigarettes is in perfect competition, what does allocative and productive efficiency imply in this case? What does it not imply?

The AAA Aquarium Co. sells aquariums for \(\$ 20\) each. Fixed costs of production are \(\$ 20 .\) The total variable costs are \(\$ 20\) for one aquarium, \(\$ 25\) for two units, \(\$ 35\) for the three units, \(\$ 50\) for four units, and \$80 for five units. In the form of a table, calculate total revenue, marginal revenue, total cost, and marginal cost for each output level (one to five units). What is the profit-maximizing quantity of output? On one diagram, sketch the total revenue and total cost curves. On another diagram, sketch the marginal revenue and marginal cost curves.

A computer company produces affordable, easy-to-use home computer systems and has fixed costs of \$250. The marginal cost of producing computers is \(\$ 700\) for the first computer, \(\$ 250\) for the second, \(\$ 300\) for the third, \(\$ 350\) for the fourth, \(\$ 400\) for the fifth, \(\$ 450\) for the sixth, and \(\$ 500\) for the seventh. a. Create a table that shows the company's output, total cost, marginal cost, average cost, variable cost, and average variable cost. b. At what price is the zero-profit point? At what price is the shutdown point? c. If the company sells the computers for \(\$ 500,\) is it making a profit or a loss? How big is the profit or loss? Sketch a graph with \(\mathrm{AC}, \mathrm{MC},\) and \(\mathrm{AVC}\) curves to illustrate your answer and show the profit or loss. d. If the firm sells the computers for \(\$ 300,\) is it making a profit or a loss? How big is the profit or loss? Sketch a graph with AC, MC, and AVC curves to illustrate your answer and show the profit or loss.

Explain in words why a profit-maximizing firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue.
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