3.4.1 Efficiency

Question 1

What is allocative efficiency?

Answer 1

This is achieved when resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised. It will occur when P=MC

Question 2

What is Productive Efficiency

Answer 2

When its products are produced at the lowest average cost so the fewest resources are used to produce each product.

The minimum resources are used to produce the maximum output.
This is where MC=AC in the short run.

Question 3

What is dynamic efficiency?

Answer 3

Efficiency improving over time through innovation, R&D, development, etc. Unlike static efficiency - at a set point in time e.g. allocative & productive.

This can only be achieved in markets where competition encourages innovation and differences in producucts. Supernormal profit is required to provide firms with the incentive to invest and the ability to do so.

Question 4

What is x-inefficiency?

Answer 4

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)

Question 5

What is efficiency like in perfect competition?

Answer 5

Productively efficient as they produce where MC=AC
Allocatively efficient as they produce where P=MC.

However, they are not dynamically efficient. No single firm will have enough for research and development. The existence of perfect information means one firm’s invention will be adopted by another firm, and so the investment will give the firm no competitive benefit.

Competition should keep costs and therefore prices low. However, firms will be unable to benefit from economies of scale and this may mean costs are higher than they could be.

Question 6

What is efficiency like in monopolistic competition?

Answer 6

Firm will not be allocatively or productively efficient, as they can only make normal profit in the long run (AC = AR) and since they profit maximise (MR = MC)

May be dynamically efficient, as there are differentiated products, and so know that innovative products will give them an edge over their competitors and enable them to make supernormal profits in the short run. However, since the firms are small, they may struggle to retain profits necessary to invest or receive finance.

Question 7

What is efficiency like in an oligopoly?

Answer 7

Not productive or allocatively efficient.

Likely to be dynamically efficient. They make supernormal profits, so they have the funds to invest and an incentive to due to competition. However, some may just share its profits with its shareholders or decide not to invest.

They will be able to exploit economies of scale, lowering costs.

Question 8

What is efficiency like in a monopoly?

Answer 8

A monopoly is productively inefficient since they don’t produce at MC = AC. They are also not allocatively efficient, as P > MC.

Since a monopolist is likely to have supernormal profits, they will be dynamically efficient. However, if there is no competition, they may have no incentive to invest.