market-structure-efficiency-and-resource-allocation

Types of Efficiency

• Different measures of efficiency are used to compare the performance of firms within markets

  • They also help to explain the behaviour of firms in the different market structures

• Static efficiency is the efficiency at a particular point in time. It can be a result of allocative or productive efficiency

  • Allocative efficiency occurs at the level of output where average revenue = marginal cost (AR = MC)

    • At this point, resources are allocated in such a way that consumers and producers get the maximum possible benefit

    • Demand = supply

    • No one can be made better off without making someone else worse off

    • There is no excess demand or supply

  • Productive efficiency occurs at the level of output where marginal cost = average cost (MC=AC)

    • At this point, average costs are minimised

    • There is no wastage of scarce resources and a high level of factor productivity

• Dynamic efficiency is long-term efficiency and is a result of innovation as a firm reinvests its profits

  • It results in improvements to manufacturing methods

  • This lowers both the short-run and long-run average total costs

  • Other types of efficiency can drive dynamic efficiency

    • E.g If productive efficiency is driven by technological advancements and innovation, it can reduce costs over time

Efficiency & Inefficiency in Different Market Structures

• Market structures are the characteristics of the market in which a firm or industry operates

  • These characteristics typically include:

    • The number of buyers

    • The number & size of firms

    • The type of product in the market (homogenous or differentiated)

    • The types of barriers to entry and exit

    • The degree of competition

• Market structures can be separated into perfect competition and imperfect competition

• Imperfect competition includes the following market structures:

  • Monopolistic

  • Oligopoly

  • Monopoly

Diagram: Efficiency and Inefficiency in Perfect and Imperfect Competition

Perfectly competitive market diagram observations

• The firm produces at the profit maximisation level of output where MC=MR (Y)

• The firm is productively efficient as MC=AC at this level of output

• The firm is allocatively efficient as AR (P)=MC

  • Demand = supply

• The firm is unlikely to experience dynamic efficiency as it is unlikely to have supernormal profits to reinvest

Imperfectly competitive market diagram observations

• The firm produces at the profit maximisation level of output where MC=MR (A)

• The firm is not productively efficient as AC > MC at this level of output (B-A)

  • Productive efficiency would occur at point E where MC=AC

• The firm is not allocatively efficient, as AR (P) > MC at this level of output (D-A)

• Demand is not equal to supply 

  • Allocative efficiency would occur where AR=MC

• The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation

Influences on Dynamic Efficiency

• Dynamic efficiency is influenced by the way a firm reinvests its profits 

  • They can reduce long term costs by investing in research and development, human capital and capital

• Investing in research and development (R&D) allows firms to allocate resources in the most optimal way. By identifying changing needs of consumers, firms can develop goods and services that match those needs

  • E.g. Pfizer’s investment into COVID-19 vaccine 

• Investing into human capital through education, training and rewards, it incentivises employees to increase labour productivity

  • E.g Google drives creativity through rewarding and training their employees 

• Investing in capital, such as technology, can improve production processes and result in long-term cost reductions

  • E.g Implementing automated technological advancements decreases production costs over time