Unit 3:

Costs of Production and

Perfect Competition

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 Efficiency

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 In general, efficiency is the optimal use
of society’s scarce resources
•Perfect Competition forces producers to use
limited resources to their fullest.
•Inefficient firms have higher costs and are the
first to leave the industry.
•Perfectly competitive industries are extremely
efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency
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 Productive Efficiency- Producing at the
lowest possible cost (minimum amount
of resources are being used)
Graphically it is where price equals the
minimum ATC
Allocative Efficiency- Producing at the
amount most desired by society
(allocating resources towards the
products society wants)
Graphically it is where price equals
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 Short-Run Profit
P Not Productively Efficient
MC

$10 MR=D=AR=P
ATC

Notice that Q1 is NOT

being made at the
lowest possible cost
(ATC not at lowest
Q1 Q point).
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 Short-Run Loss
P Not Productively Efficient
MC

ATC

MR=D=AR=P
$5
Notice that Q2 is NOT
being made at the
lowest possible cost
(ATC not at lowest
Q2 Q point).
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 Long-Run Equilibrium
P Productively Efficient in the Long-Run
MC

ATC

$8 MR=D=AR=P

In the long-run, Q2 IS
being made at the
lowest possible cost
(ATC at lowest point)
Q3 Q
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 Short-Run Profit
P Allocatively Efficient
MC
$10 MR=D=AR=P
ATC

Notice that the price

people are willing to
pay equals the
additional cost to
Q1 Q produce Q1
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 Short-Run Profit
P NOT Allocatively Efficient
MC
$10 MR=D=AR=P
ATC

$5
At Q2, the price is greater
than the MC so society
wants more output
produced
Q2 Q
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 Long-Run Equilibrium
P
MC

ATC

$8 MR=D=AR=P
A perfectly
competitive profit
maximizing firm is
always allocatively
Q3 Q
efficient
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 Summary
Perfectly competitive firms are
allocatively and productively
efficient in the long run.

In the short run, they are always

allocatively efficient, but they are
not productively efficient.

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2005 Exam

17
2010 Exam

18
 Review
1. Why isn’t a perfectly competitive firm
productively efficient when earning a positive
economic profit in the short run?
2. Why isn’t a perfectly competitive firm
productively efficient when earning a negative
economic profit in the short run?
3. Why are perfectly competitive firms ALWAYS
allocatively efficient, whether in the short or long
run?
4. They are producing a quantity greater than minimum
ATC.
5. They are producing a quantity less than minimum ATC.
6. PC firms always produce where P=MC

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 How the Sharing Economy
Liberates Us
Read the above article and consider the following questions:
● The article claims that, “The conventional approach to
commerce, which fences off and excludes personal assets,
leaves resources idle and impedes allocative efficiency.” The
author doesn’t specify what she means by this claim. Based on
the article and your knowledge of the subject, how can the
sharing economy improve allocative efficiency?

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