allocative efficiency

• Free market equilibrium


  Efficient allocation of scarce resources
• Achieving efficient allocation of scarce resources in a free market

  1. Understand why P* and Q* is allocated efficiently

  2. Build a model with supply, demand, private costs, social costs, private benefits, social benefits

  3. Prove that at equilibrium, 3 things occur: 1) Maximisation of social surplus 2) Maximisation of net social benefit 3) Perfect allocation of resources to follow consumer demand
• Assumptions for free market equilibrium to be efficient


  • Many buyers and sellers
  • Perfect information for consumers and producers
  • No barriers to entry or exit
  • Firms are profit maximisers
  • Consumers are utility maximisers
• If assumptions are violated


  There may be a difference between the private optimum (where MPC=MPB) and the social optimum (where MSC=MSB), leading to market failure
• Differences between private optimum and social optimum is where market failures can come from