Efficiency (1)

Allocative efficiency

• Occurs at the level of output where average revenue = marginal cost (AR = MC)

• At this point, resources are allocated in a way that consumers and producers receive the maximum possible benefit

• No one can be made better off without making someone else worse off

• There is no excess demand or supply

Productive efficiency

• Occurs at the level of output where marginal cost = average cost (MC=AC)

• At this point, average costs are minimised

• There is no wastage of scarce resources and there is a high level of factor productivity

Dynamic Efficiency

• Long-term efficiency is a result of innovation as a firm reinvests its profits

• It results in improvements to manufacturing methods

  • This lowers both the short-run and long-run average total costs

X - inefficiency

• Occurs when a firm lacks the incentive to control production costs. Slack occurs as a consequence

• The ATC is higher than it should be

• It often occurs in an industry if there is a lack of competition or in a firm that is not accountable for making a loss (e.g. some government owned companies)

What are market structures ?

• Market structures are the characteristics of the market in which a firm or industry operates

  • These characteristics typically include

    • The number of buyers

    • The number and size of firms. The market's concentration ratio

    • The type of product in the market (homogenous -Products sold by competing firms are identical and indistinguishable from each other or differentiated -Unique products that are substantively (or perceived to be) different from competitors products )

    • The types of barriers to entry and exit

    • The degree of competition

What can market structures be separated into ?

• Perfect competition - A market structure in which individual firms have no market power due to the amount of competition & are unable to influence the price

• Imperfect competition - Market structures where firms do have some market power and can influence prices i.e.monopolistic, oligopoly & monopoly

  • Imperfect competition includes the following market structures

    • Monopolistic

    • Oligopoly

    • Monopoly

A perfectly competitive market on the top which experiences allocative and productive efficiency. An imperfect market on the bottom in which inefficiencies exist at the profit maximisation level of output

Perfectly competitive market diagram observations

• The firm produces at the profit maximisation level of output, where MC=MR (Y)

• The firm is productively efficient as MC=AC at this level of output

• The firm is allocatively efficient as AR (P)=MC

• The firm is unlikely to experience dynamic efficiency as it is unlikely to have supernormal profits to reinvest

Imperfectly competitive market diagram observations

• The firm produces at the profit maximisation level of output, where MC=MR (A)

• The firm is not productively efficient as AC > MC at this level of output (B-A)

  • Productive efficiency would occur at point E, where MC=AC

• The firm is not allocatively efficient as AR (P) > MC at this level of output (D-A)

  • Allocative efficiency would occur where AR=MC

• The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation