Efficiency in the Market - Essay Example

It requires goods to be produced in the least cost way. The firms are forced at the minimum level of average cost in the long run. The consumers are benefitted under productive efficiency as they are required to pay the lowest possible product price. Allocative efficiency is given by the equality between price and marginal cost. It requires firms to take that production path that is the need of the society. When the firm is not able to increase its welfare by producing more of one good then a situation of efficient allocation is said to exist.

A firm can achieve such efficiency by equating marginal cost and price. Marginal cost is regarded as the amount of satisfaction foregone due to the production of another good. If P=MC then value of produced goods is equal to the value of not produced goods. Considering a hypothetical country and a firm who is a price taker, the firm will produce at the profit maximizing quantity which will equate price and marginal cost. The firm will face U-shaped cost curves and horizontal demand curve. 1 Perfect competition can efficiently allocate resources in the long run.

The following is the long run equilibrium condition: P=SRMC=LRMC=SRAC=LRAC This equation states prices to be equal to marginal cost and average cost both in the long and short run. With P+MC no firm has the motive to make adjustments in quantity. Again with P=AC each firm earns only normal profit. This is a situation of no economic profit-loss situation. The long run condition is satisfied only at the minimum of LRAC curve. This is also termed as the minimum efficient scale. The minimum efficient scale provides the economy to utilize resources in optimal and efficient fashion.

Two types of agents participate in the competitive market. The other participant is scarce resources. In the economy framework a resource is defined as the item (goods or services) that is valued by the agents. It is the scarcity of resources which calls for efficient allocation of resources to satisfy all the participating agents. The decisions on allocation are of prime importance in this market principle. A market is defined as the place where buyers meet sellers. The mode with which the exchange takes place is called price.

The main characteristic of competitive market is the adjustment of prices until supply is equal to demand. The price sets the market in equilibrium and such a situation is called Pareto optimal situation. In a decentralized economy the equilibrium price is determined by tatonnement process. Prices tend to rise if demand is greater than supply and decrease when demand is less than supply. An adjustment to occur the demand and supply at the current prices must be known beforehand. Consider the case where there are many independent sellers.

If there access to full information to both the buyers and the sellers then price of the product will set at the equilibrium. Now suppose a high price and a low price is charged for the product. The consumers may opt firms selling their products at high price to offer at some price level which is the difference between the high and low price. Such a situation will offer a better off situation for both parties. The quantities are in the Y-axes. The equilibrium price is denoted as p*. At this price the buyers will be willing to pay at least this amount of price to buy the products and the firms will be able to sell their products at the market rate.

If the price is less than the equilibrium p