Productive and

Allocative Efficiency

Allocative EfficiencyAllocative efficiency: a situation where it is impossible to reallocate the resources to make at least one person better off without making someone else worse off.

In such a case the welfare of society cannot be improved by reallocating the resources.

Society’s welfare maximised (allocatively efficient) when…

P (OC of consuming extra unit) =

MC (OC of producing extra unit)

Are perfectly competitive firms allocatively efficient?•P = MR•Profit maximisation at MR = MC•Therefore they produce at P = MR = MC

Productive efficiency

Productive efficiency: occurs when all the firms in the industry produce where their average or unit costs are at a minimum.

When this occurs – no waste of scarce resources.

Perfectly competitive firms in equilibrium in the long run where average cost is at a minimum – thus productively efficient.

Allocative and Productive Efficiency in Perfect Competition

Does Perfectly Competitive firm produce at lowest AC in long run?YES – productively efficientDoes Perfectly Competitive firm produce where

P = MC?YES – allocatively efficient

Allocative and Productive Efficiency in a Monopoly

Does monopoly produce at lowest AC in long run?

NO – productively inefficientDoes monopoly produce where P = MC?

NO – allocatively inefficient

Allocative and Productive Efficiency in a Monopolistically Competitive Firm

Does a monopolistically competitive firm produce at lowest AC in long run?NO – productively inefficientDoes a monopolistically competitive firm

produce where P = MC in the long run?NO – allocatively inefficientShort run position Long run position