CHAPTER 6

6.5 Efficiency (Productive Efficiency and Allocative Efficiency)

SLIDE 1
Efficiency in Imperfect Market
(An imperfect market is defined as any market that does not satisfy the functions and features of
completely competitive markets. Let’s say in perfect market a firm’s control the prices, no
barriers to entering or leaving the market, sell the same product and services, same industry
information or knowledge, and there’s a lot of suppliers and buyers. If any of these conditions is
absent then it is what you called “imperfect market”)
a. Economic Effects of Monopoly: Price, Output, and Efficiency
Explain: Monopoly is a type of imperfect market (so) where a seller or producer captures the
majority of the market share due to the lack of substitutes or competitors.
Their output is restricted in order to maximize profit and without market competitors, that make
difficult for a monopoly to self-regulate and stay competitive over time.
Then the next diagram graphically contrasts the price, output, and efficiency outcomes of pure
monopoly and a purely competitive industry.
Explain: Take a look at Figure A, In the figure a, as you can see the S = MC (Supply equal
Marginal Cost) curve which is the red line that reminds us that the market supply curve S for a
purely competitive industry is the horizontal sum of the marginal cost curves of all the firms in
the industry. Assume there are 1000 such businesses. Comparing their combined supply curves
S with market demand D, we see that the purely competitive price and
output are Pc and Qc.
In the figure b, since the monopolist does not have a supply curve, as such, the S label become
the marginal-cost curve (MC) of the monopolist, the summation of the individual marginal-cost
curves of its many branch plants. Also at Qc, the output is less than that required for achieving
minimum ATC if you look at the figure a, which reminds us that pure monopoly is inefficient
because the monopolist’s price exceeds MC. And if you look at the point abc that created a
triangle form called “efficiency loss” because of the monopoly pricing since the business
disregards trades with customers.
SLIDE 2
Inefficiency of pure monopoly relative to a purely competitive industry.
inefficiency of pure monopoly in comparison to purely competitive industry is that
(a) In a purely competitive industry, entry and exit of firms ensure that price (Pc) equals
marginal cost (MC) and that the minimum average-total- cost output (Qc) is produced.
Explain: In short, productive efficiency (P = minimum ATC) is achieved because they
operate where average total cost is at a minimum and allocative efficiency (P = MC) is
obtained because production occurs up to that output at which price equals marginal
cost.

SLIDE 3
(b) In pure monopoly, the MR curve lies below the demand curve. The monopolist
maximizes profit at output Qm, where MR = MC, and charges price Pm.
Explain: In short, the output is lower (Qm rather than Qc) and price is higher (Pm rather
than Pc) than they would be in a purely competitive industry. This means that marginal
revenue is less than price, that shows the MR curve lies below demand curve D. The
comparison of both graphs in the previous figure reveals that the monopolist finds it
profitable to sell a smaller output at a higher price than do the competitive producers.

SLIDE 4
b. Monopolistic Competition and Efficiency
A monopolistic competition is also a type of imperfect market where many sellers try
to capture the market share by differentiating their products.
A few examples are clothing stores that sell clothing trends, eateries or grocery stores
that food varieties, and even goods like beer or golf balls that may be at least apparently
similar yet have different public perceptions due to branding and advertising.
(so) In monopolistic competition, neither productive nor allocative efficiency occurs in
long-run equilibrium.
Explain: It means a monopolistically competitive firm is not productively efficient
because it does not produce at the minimum of its average cost curve. A
monopolistically competitive firm is not allocatively efficient because it does not produce
where P (Price) = MC (Marginal Cost) but instead produces where P is greater than >
MC. Thus, making the monopolistically competitive firm to produce a lower quantity at a
higher cost and to charge a higher price than a perfectly competitive firm.
The figure includes an enlargement of part of Figure c and clearly shows this. First note
that in monopolistically competitive, the profit-maximizing price P3 slightly exceeds the
lowest average total cost, A4.

SLIDE 5
The inefficiency of monopolistic competition. (so like what I said earlier) In long-run
equilibrium a monopolistic competitor achieves neither productive nor allocative
efficiency.
Explain: Because as you can see in the figure, the productive efficiency is not realized
because production occurs where the average total cost A3 exceeds the minimum
average total cost A4 and the allocative efficiency is not achieved because the product
price P3 exceeds the marginal cost M3. And the results are an under allocation of
resources as well as an efficiency loss and excess production capacity at every firm in
the industry. This firm’s efficiency loss is area acd and its excess production capacity is
Q4 - Q3.
To measure the size of this inefficiency, note that the allocatively optimal amount of
output is determined by point c, where demand curve D intersects the MC curve. (So,
for all units between Q3 and the level of output associated with point c, marginal
benefits exceed marginal costs. Consequently, by producing only Q3 units, this
monopolistic competitor creates an efficiency loss (deadweight loss) equal in
size to area acd) The total efficiency loss for the industry as a whole will be the sum of
the individual efficiency losses generated by each of the firms in the industry.

SLIDE 6
c. Oligopoly and Efficiency
In an oligopoly, there is typically and under allocation of resources where price exceeds
marginal cost and average total cost, making oligopolies both productively and
allocatively inefficient.
For which of the following reason(s) are oligopolies inefficient?
 Oligopolists also do not typically produce at the minimum of their average cost
curves.
 They lack vibrant competition, which lack incentives to provide innovative
products and high-quality service
Many economists believe that the outcome of some oligopolistic markets is
approximately as shown in the following figure.

In this view, neither productive efficiency

(P5 minimum ATC) nor allocative efficiency
(P = MC) is likely to occur under oligopoly.

Explain: As you can this figure, If a firm raises its price (D), but the others do not match
the increase, then revenue will decline in spite of the price increase. If the firm lowers its
price (D), then the other firms will match the decrease to avoid losing market share. As
a result, they produce too little output so they create deadweight losses to society. In
short here in (P0 and A0) the higher their profits and the greater the deadweight loss
which explains why oligopolistic firms change prices less frequently than firms operating
under other market models.

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 Pure Monopoly Main Characteristics
1. Single Seller A pure monopoly is an industry in which a
single firm is the sole producer of a specific
good or the sole supplier of a services.
2. No Close Substitute No close substitutes exist for the product sold
by the pure monopoly because pure
monopoly’s product is unique and different
from each other.
3. Price Maker In pure monopoly, they controls the total
quantity supplied and thus has considerable
control over price.