Perfectly competitive markets are economic powerhouses, achieving both productive and allocative efficiency. Firms produce at minimum costs and set prices equal to marginal costs, maximizing total economic surplus. This optimal resource allocation benefits both consumers and producers.

Real-world markets often deviate from perfect competition, leading to inefficiencies. Monopolistic competition, oligopolies, and monopolies introduce market power and barriers to entry. Government intervention may be necessary to address these market failures and promote efficiency.

Efficiency in Perfectly Competitive Markets

Productive and Allocative Efficiency

• Productive efficiency
  • Firms produce at minimum long-run average total cost curves to remain competitive and maximize profits
  • Price takers face perfectly elastic demand curve
• Allocative efficiency
  • Price equals marginal cost of production at market equilibrium
  • Intersection of market demand and supply curves determines market price
  • Resources allocated optimally, maximizing consumer and producer surplus (total economic surplus)

Profit Maximization and Economic Efficiency

• Profit maximization
  • Firms maximize profits by producing where marginal revenue equals marginal cost ($MR = MC$)
  • Price takers have $MR = P$ (market price)
  • Firms produce where $P = MC$
• Economic efficiency
  • Productive efficiency: firms minimize long-run average total costs
  • Allocative efficiency: $P = MC$
  • Profit maximization leads to productive and allocative efficiency
  • Pursuit of self-interest by firms results in socially optimal outcomes (invisible hand)

Perfect Competition vs. Real-World Markets

• Perfect competition assumptions
  • Many buyers and sellers
  • Homogeneous products
  • Free entry and exit
  • Perfect information
  • No transaction costs or externalities
• Real-world market structures
  • Monopolistic competition
    • Many sellers with differentiated products (fast food, clothing)
    • Low entry and exit barriers
  • Oligopoly
    • Few large sellers dominating market (automotive, telecommunications)
    • High entry barriers
  • Monopoly
    • Single seller without close substitutes (public utilities, patented drugs)
    • High entry barriers
• Deviations from perfect competition
  • Market power: non-competitive firms have some price control
  • Inefficiencies: non-competitive markets may not achieve productive or allocative efficiency
  • Government intervention: regulations, subsidies, or taxes address market failures and promote efficiency (antitrust laws, price controls)