Market Structure, Efficiency & Resource Allocation (AQA A Level Economics)

• Different measures of efficiency are used to compare the performance of firms within markets
  • They also help to explain the behaviour of firms in the different market structures

• Static efficiency is the efficiency at a particular point in time. It can be a result of allocative or productive efficiency

• • Allocative efficiency occurs at the level of output where average revenue = marginal cost (AR = MC)
    • At this point, resources are allocated in such a way that consumers and producers get the maximum possible benefit
    • Demand = supply
    • No one can be made better off without making someone else worse off
    • There is no excess demand or supply
  • Productive efficiency occurs at the level of output where marginal cost = average cost (MC=AC)
    • At this point, average costs are minimised
    • There is no wastage of scarce resources and a high level of factor productivity

• Dynamic efficiency is long-term efficiency and is a result of innovation as a firm reinvests its profits
  • It results in improvements to manufacturing methods
  • This lowers both the short-run and long-run average total costs
  • Other types of efficiency can drive dynamic efficiency
    • E.g If productive efficiency is driven by technological advancements and innovation, it can reduce costs over time

• Market structures are the characteristics of the market in which a firm or industry operates
  • These characteristics typically include:
    • The number of buyers
    • The number & size of firms
    • The type of product in the market (homogenous or differentiated)
    • The types of barriers to entry and exit
    • The degree of competition
      
      
• Market structures can be separated into perfect competition and imperfect competition
  
  
• Imperfect competition includes the following market structures:
  • Monopolistic
  • Oligopoly
  • Monopoly

Diagram: Efficiency and Inefficiency in Perfect and Imperfect Competition

A perfectly competitive market at the top that experiences allocative & productive efficiency. An imperfect market on the bottom in which inefficiencies exist at the profit maximisation level of output

Perfectly competitive market diagram observations

• The firm produces at the profit maximisation level of output where MC=MR (Y)
• The firm is productively efficient as MC=AC at this level of output
• The firm is allocatively efficient as AR (P)=MC
  • Demand = supply
• The firm is unlikely to experience dynamic efficiency as it is unlikely to have supernormal profits to reinvest

Imperfectly competitive market diagram observations

• The firm produces at the profit maximisation level of output where MC=MR (A)
• The firm is not productively efficient as AC > MC at this level of output (B-A)
  • Productive efficiency would occur at point E where MC=AC
• The firm is not allocatively efficient, as AR (P) > MC at this level of output (D-A)
• Demand is not equal to supply 
  • Allocative efficiency would occur where AR=MC
     
• The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation

• Dynamic efficiency is influenced by the way a firm reinvests its profits 
  • They can reduce long term costs by investing in research and development, human capital and capital
     

• Investing in research and development (R&D) allows firms to allocate resources in the most optimal way. By identifying changing needs of consumers, firms can develop goods and services that match those needs
  • E.g. Pfizer's investment into COVID-19 vaccine 
    
    

• Investing into human capital through education, training and rewards, it incentivises employees to increase labour productivity
  • E.g Google drives creativity through rewarding and training their employees 
    
    

• Investing in capital, such as technology, can improve production processes and result in long-term cost reductions
  • E.g Implementing automated technological advancements decreases production costs over time