- Productive efficiency
- Productive efficiency means producing without waste, so that goods are produced and sold at the lowest possible average cost.
- Allocative efficiency
- Allocative efficiency means producing the quantity where the marginal benefit to society of one more unit just equals its marginal cost.
Efficiency in each market structure
Can you say how efficient each of the four market structures is?
The two tests are the same for every structure: is price equal to marginal cost, and is output at the lowest point of average cost?
Perfect competition is allocatively efficient in the short and long run, since price equals marginal cost, and productively efficient in the long run, when entry pushes price to minimum average cost.
Can you think of an example?
Wholesale flower growers each sell at the market price. New growers enter while there is profit to be had, until every grower sells at the bottom of its average cost curve.
Monopoly is allocatively inefficient, because its price is always above marginal cost, and it does not produce at the lowest point of its average cost curve.
Can you think of an example?
A sole ferry operator to an island charges well above the cost of carrying one more passenger, so trips that travellers would value at more than their cost are never sold.
Monopolistic competition is neither productively nor allocatively efficient, since price is above marginal cost and entry leaves firms on the falling part of average cost.
Can you think of an example?
A high street has a dozen hairdressers, each with spare chairs. Each could cut hair more cheaply per head if it had more customers, but the customers are spread thinly among them.
Oligopoly does not typically produce at the minimum of average cost, and where firms collude they hold price above marginal cost like a monopoly.
Can you think of an example?
A few large firms supply most of the country's cement. When they avoid undercutting each other, their prices stay above marginal cost and output is below the efficient level.