A perfectly competitive industry achieves allocative efficiency in the long run. What does allocative efficiency mean?
A. Firms use an input combination that minimizes cost and maximizes output.
B. Production occurs at the lowest average total cost.
C. Each firm produces up to the point where the price of the good equals the marginal cost of producing the last unit.
D. Each firm produces up to the point where all scale economies are exhausted.
The correct answer and explanation is :
Correct Answer: C. Each firm produces up to the point where the price of the good equals the marginal cost of producing the last unit.
Explanation (300 words):
Allocative efficiency occurs when the mix of goods and services produced in an economy represents the preferences and desires of consumers. In other words, it happens when resources are distributed in such a way that it is impossible to make someone better off without making someone else worse off. This is a key outcome in a perfectly competitive market.
In the long run, a perfectly competitive industry achieves allocative efficiency because firms produce at the level of output where price equals marginal cost (P = MC). This condition ensures that the value consumers place on a good (reflected in the price they are willing to pay) is exactly equal to the cost of the resources used to produce the last unit of that good.
Option C captures this concept precisely. If firms were producing where P > MC, it would indicate underproduction—consumers value the product more than it costs to produce, and more should be made. Conversely, if P < MC, it would indicate overproduction—resources could be better used elsewhere. Thus, only when P = MC is the correct quantity of goods being produced from a societal standpoint.
While the other options describe important concepts:
- Option A refers to productive efficiency related to cost-minimization, not allocative efficiency.
- Option B reflects productive efficiency, not allocative efficiency.
- Option D speaks to long-run scale economies, again not directly about matching production to consumer preferences.
Therefore, Option C best reflects the definition of allocative efficiency, where the value to consumers equals the opportunity cost of production. This is achieved naturally in perfectly competitive markets due to the forces of supply and demand driving prices to match marginal costs.
