Though perfect competition is a myth, but, it leads to the survival of the fittest. In this market form, relatively less efficient firms are thrown out of the market.
Consequently, a good deal of economic efficiency prevails, resulting in low cost of product through the most optimal use of scarce manpower and other economic resources. Further, there is no economic waste on advertisement under perfect competition. Finally, the welfare of the people is maximised, as all the firms earn only normal profits.
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Allocative Efficiency under Perfect Competition:
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Demand-supply analysis can be used to explain both consumer surplus as well as producer surplus, shown in Fig. 13.14. Consumer surplus is the difference between the total amount that the consumer is willing to pay rather than doing without the commodity and the actual amount that he spends in acquiring the commodity.
It is given by the area (OAEQ – OPEQ) = area APE. ‘E’ is the equilibrium point, where the demands curve AD and the supply curve BS intersects each other.
Producer surplus is defined as the difference between the actual amount that a producer receives by selling a given quantity of a commodity and the minimum amount that he expects to receive for the same quantity of a commodity in order to cover the cost of production. In Fig. 13.14, it is given by the area (OPEQ – OBEQ) = area BPE.
The two surpluses together represent the total gains to the consumers and producers participating in economic activity. Their sum would be maximum when the market structure is perfectly competitive.
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Efficient allocation of resources among various alternatives involves the problem of choice. Resources are efficiently allocated when with the given resources, sum of consumer and producer surplus is maximised as shown in Fig. 13.14.
Here, there is no possibility of making consumers or producers better off without making the others worse off. Allocative efficiency is achieved, when price is equal to marginal cost.
Allocative efficiency is one condition of economic efficiency, which requires avoiding the wastes of resources. Other condition of economic efficiency is productive efficiency, which occurs when it is impossible to reallocate resources to produce more of some product without producing less of some other product.
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This implies that each firm should produce any given output at the lowest possible cost and the marginal cost of producing the last unit of output is same for each firm in the industry. Productive efficiency is achieved under perfect competition as all firms in an industry have identical marginal costs and identical minimum cost in long run equilibrium.