Question

Perfect competition is considered to be the most efficient market structure. In a short essay (3 paragraphs), using a graph or two, explain this concept fully. How do Imperfect markets cost society? What is lost? Be specific, define your terms, and give examples.

Answer 1

In perfect competition will maximize their profit at the point where price is equal to marginal cost. The firms are price taker that is they don't have the market power. Therefore, the market is dependent on the market forces demand and supply.  

The perfectly competitive market achieves higher efficiency because the price is equal to the marginal cost.

Refer the attached graph of a perfectly competitive market

As we can see from the above graph the perfectly competitive industry is supplying the quantity at which the price is equal to marginal cost. The area below the demand curve and above the marginal cost is the consumer surplus. Under this market there is no deadweight loss associated. Thus, the total surplus is maximized.

Р Perfect Competition Consumer Surplus MC Qp

In case of imperfect market competition the firms have certain influence on the market price thus it gives rise to dead weight loss.

Imperfect Market Pm DWL MC 5 20 25 35 Qm Qp

As we can see from the above graph there is dead weight loss due to market power. That is the industry is producing less than the efficient output. The firms maximize profit at the point where MR = MC. Therefore, we have to pay a higher price because the firms are producing less than the efficient output as they have created a shortage.

The area represents the loss to the society due to market power.

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