Question

A market is allocatively efficient. What does that mean in terms of prices, marginal utility, and marginal costs? Explain your logic please.

Answer 1

when a market is said to be allocatively effiicient it means that its price is equal to marginal costs in a perfect market.

that is P=MC.

The price that the consumers are willing to pay is equal or same as that of the marginal utility which they get. Hence, optimal distribution can be achieved when the marginal utility of the goods is equal to the marginal cost.

From fig 1, at an output 30 marginal cost(MC) is 5$ but people are willing to pay a price of 15$. Here the price is greater than marginal cost.So it is is under consumption

From fig 2, at the output of 70 marginal cost(MC) is 15$(price) but people are willing to pay a price of only 5$. Here the marginal cost(15$) is greater than marginal benefit(5$).So it is is over-consumption.

Allocative efficiency will occur at price 10$. Here marginal cost =marginal utility.