Explain how perfect competition should lead to outcomes which are both productively and allocatively efficient

AQA A-Level Economics Paper 1 June 2021

Explain how perfect competition should lead to outcomes which are both productively and allocatively efficient. (15 marks)

Perfect competition is a market structure that is characterised by many buyers and sellers, firms selling identical products, perfect information, and no barriers to entry or exit.

In the short run, the outcomes of perfect competition can be seen by this diagram.

1. the diagram on the left shows that the market price is the equilibrium between supply and demand.
2. firms in perfect competition are price takers so the firm's AR curve follows this price.
3. firms cannot sell at a higher price as they would get zero demand due to the many other sellers who sell identical products.
4. firms are profit maximisers so they choose to sell the quantity where MC = MR.
5. in the short run, firms are able to achieve allocative efficiency because, at q1, AR = MC. This means that consumer surplus is maximised.
6. consumer surplus is the difference between the price paid and the maximum price consumers are willing to pay for the good or service.
7. the firm does not achieve productive efficiency in the short-run because the firm is not operating at the lowest point of their average cost curve.

1. the firm is able both allocatively and productively efficient in the long run.
2. since there are supernormal profits in the short-run and no barriers to entry, this incentivises new firms to enter the market.
3. this means that market supply will increase.
4. as a result, each firm sees a decrease in demand because there are more perfect substitutes available.
5. this can be seen by a downward shift in the firms' average revenue and marginal revenue curves.
6. the outcome in the long-run outcome is allocatively efficient since AR = MC.
7. this means that consumer surplus is still being maximised, and this is possible since firms are forced to be price takers and charge the market price for the good.
8. firms are also able to achieve productive efficiency in the long-run as they now operate at the lowest point of the AC curve (AR = MC).
9. this means that firms are fully exploiting their economies of scale, and this allows firms to charge consumers lower prices.
10. finally, firms are not able to achieve dynamic efficiency as there is no supernormal profit in the long-run.

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