Economic efficiency is one of the most important
concepts in economics, used for example as a criterion
for judging the ways in which perfect competition and
other market structures affect resource allocation in
the economy. To make such a judgement, you must be
familiar with a number of different types of economic
efficiency, which include productive efficiency and
allocative efficiency.
Productive efficiency occurs when a firm produces at
the lowest point on its average cost curve. Allocative
efficiency requires that the price of the good equals the
marginal cost of production (P = MC). Figure 4 appears to
show that in long-run equilibrium a perfectly competitive
firm is both productively and allocatively efficient.
Revenue and cost
Competition and the efficient allocation
of resources
MC
P3
ATC
AR = MR
X
Point X is
● productively efficient
●�allocatively efficient
0
Q3
Output
Figure 4 A perfectly competitive firm is productively and
allocatively efficient
l (P > MC). Why will this result in allocative inefficiency? (AO3)
5 Suppose the price of a good is greater than the marginal cost of production
4 marks
The dynamics of competition and
competitive market prices
If real-world markets were perfectly competitive, price
competition, in the form of price wars or price-cutting
by individual firms, would not take place. In perfect
competition, all firms are passive price takers, able to
sell all the output they produce at the ruling market price
determined in the market as a whole. In this situation,
firms cannot gain sales or market share by price cutting.
Other forms of competition, known as non-price
competition, which involve the use of quality
competition, persuasive advertising, packaging,
brand imaging or the provision of after-sales
service to differentiate a firm’s product from those of
its competitors, simply destroy the conditions of perfect
competition.
These are the forms of competition that are prevalent,
together of course with price competition, in the
imperfectly competitive markets of the real economy in
which we live.
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information and that any supernormal profits resulting
from successful cost-cutting can only be temporary?
6 Explain the difference between price competition and quality competition. (AO1)
l
4 marks
l competition. Describe two ways in which use of the internet does this. (AO1, AO2)
4 marks
Competitive markets
Although perfect competition does not and cannot exist
in the world we live in, some of the markets and industries
we usually regard as ‘competitive’ display some but not all
of the characteristics of perfect competition. Some, such
as many agricultural markets and the markets for shares
and currencies, approximate to perfect competition.
TOPIC 2
One form of competition could take place in
perfectly competitive markets. This is cost-cutting
competition. Each firm in a perfectly competitive
market would have an incentive to reduce costs in order
to make supernormal profit. But even the existence
of cost-cutting competition in a perfect market can
be questioned. Why should firms finance research
into cost-cutting technical progress when they know
that other firms have instant access to all market
7 Economists believe that the internet is making some markets closer to perfect
Exam-style questions (essays)
Write your answers on a separate sheet of paper and keep them with your workbook for
reference.
l
01 Explain how price and output are determined in a perfectly competitive
market, both for the whole market and for one firm within the market.
(AO1, AO2, AO3)
15 marks
l
02 Evaluate the view that perfect competition is economically efficient,
both in the short run and in the long run. (AO2, AO3, AO4)
25 marks
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38
Answers on www.hodderplus.co.uk/philipallan/workbooks
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