Economic Efficiency, Questions and Answers

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Question:1 (a) What market structure is used to benchmark allocative efficiency and why do we use it? Illustrate and explain using a diagram Ans: Allocative efficiency is an economic efficiency in which producers produce goods and services which are highly in preference by the consumers. In allocative efficiency price is equal to marginal cost of production. At this price consumer will willing to pay as it is equivalent to marginal utility. Allocative efficiency is used when firm minimize the cost of input require to produce given number of outputs. This is maximizing the input or output ratio. This can be better explain with the help of diagram given below. Graph: Explanation: • If the marginal cost was $10, and customer were only willing to pay $5 for the goods (at output 5), this is allocatively inefficient. • This is because the value customer get ($2) is less than the cost of producing. • The cost is greater than the benefit and it is inefficient. • If the marginal cost of a good was $5, and the price was $10. • The price Marginal utility (MU) is greater than marginal cost – suggesting under consumption. • If output increased and price fall, society would benefit from enjoying more of the good. Allocative efficiency occurs at an output of 8. (b) Why and how do monopolistically competitive firms fail to achieve allocative efficiency? Illustrate and explain using a diagram. Ans: Monopoly means a single seller in the market. So monopoly receives enjoy the maximum profits by selling the goods. The seller is the price maker of the product. Monopoly inefficiency cannot throughout the life in the short run. In monopolies competition the firm maximum profits by producing marginal revenue which i... ... middle of paper ... ...am shows the cost curves of a firm under perfect competition. (a) How much will the firm produce in order to maximise profits at a price of $8 per unit? Ans: 70 Units (b) What will be its average cost of production at this output? Ans: $6 (c) How much (supernormal) profit will it make? Ans: $2*70=$140 (d) How much will the firm produce in order to maximise profits at a price of $5 per unit? Ans: 50 Units (e) How much (supernormal) profit will it make? Ans: $0 (f) How much will the firm produce in order to maximise profits at a price of $4 per unit? Ans: 40 Units (g) What will be its profit value be now? Ans: A loss of $1.50 * 40 = $60 (h) Below what price would the firm shut down in the short run? Ans: $3.50 (Where P = AVC) (i) Below what price would the firm shut down in the long run? Ans: $5 (Where P = AC)

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