Allocative Efficiency

• Allocative Efficiency

  An optimal distribution of goods and services, taking into account consumer's preferences
• Allocative efficiency

  At an output level where the Price equals the Marginal Cost (MC) of production
• Price equals marginal cost

  The optimal distribution is achieved when the marginal utility of the good equals the marginal cost
• Perfect Competition - Allocatively efficient

  • Firms in perfect competition are said to produce at an allocative efficient level because at Q1,  P=MC

  A) Firm in Perfect Competition

  B) Industry in Perfect Competition

  C) MC

  D) AC

  E) D=AR=MR

  F) Supply

  G) Demand

  
• Monopolies - Allocatively inefficient

  Monopolies can increase price above the marginal cost of production and are allocatively inefficient.

  This is because monopolies have market power and can increase price to reduce consumer surplus.
• Monopolies - Allocatively inefficient Diagram Example

  • Monopoly sets a price of Pm. This is allocatively inefficient because at this output of Qm, price is greater than MC.
  • Allocative efficiency would occur at the point where the MC cuts the Demand curve so Price = MC.
  • The area of deadweight welfare loss shows the degree of allocative inefficiency in the economy.

  A) MC

  B) AC

  C) D=AR

  D) MR

  E) Supernormal Profits

  F) Deadweight Welfare Loss

  
• Allocative efficiency example:

  At an output of 40, the marginal cost of the good is £ 6, but at this output, consumers would be willing to pay a price of £ 15

  The price (which reflects the good’s marginal utility) is greater than marginal cost – suggesting under-consumption.

  If output increased and price fell, society would benefit from enjoying more of the good.

  A) Supply

  B) MC

  C) Demand

  D) MU

  E) Allocatively efficient

  F) MU

  G) MC

  H) Allocatively inefficient

  I) MU

  J) MC

  
• Allocative Efficiency example 2

  At an output of 110, the marginal cost is £ 17, but the price people are willing to pay is only £ 7.

  At this output, the marginal cost (£ 17) is much greater than the marginal benefit (£ 7) so there is over-consumption.

  Society is over-producing this good.

  Allocative efficiency will occur at a price of £ 11. This is where the marginal cost (MC) = marginal utility.

  A) Supply

  B) MC

  C) D

  D) MU

  E) Allocatively inefficient

  F) MC

  G) MU

  H) Allocatively efficient

  I) MU

  J) MC