This is an economic efficiency where the producers try to satisfy the maximum want of the consumers. In other words, when the society achieves optimal distribution of goods and services, taking into account the preferences of the consumer, it is said to be allocative efficient. In the economic literature, it is defined as an economic state where the price of the product equals its marginal cost as at this point the price which the consumers are willing to pay is equivalent to the marginal utility they get from the product. Below is the ranking of the market structures in terms of their allocative efficiency:
- Perfect Competition: Under this kind of market structure, all the firms produce their product at the level of P= MC. In other words, since price is equal to the marginal cost, there will be no deadweight loss to the society and consumer and producer surplus is maximized.
- Monopolistic Competition: Firms under this market structure produce their product at the price which is greater than the marginal cost, which means that the society does not enjoy full efficiency and a deadweight loss is generated. Thus, firms under monopolistic competitive market are least allocative efficient as compared to firms under perfect competitions.
- Monopoly: Firms under monopoly market structure are known to enjoy the price dominance because of unavailability of any close substitutes. As a result, they always produce a product at a price that is higher than the marginal cost and they usually increase the price to reduce the consumer surplus. All such factors turns the monopoly market structure allocative inefficient.
- Oligopoly: This market structure is least allocative efficient and are less desirable than monopoly itself because a very few firms operate under this market structure and they charge price well above their marginal cost leading to allocative inefficiency.
This is an economic efficiency that is concerned with the production of goods and services at the lowest possible cost. In other words, a productive efficient firm, always produce their product at lowest point of ATC. Below is the ranking of the market structures in terms of their production efficiency:
- Perfect Competition: Firms operating under perfect competition are indeed productive efficient both in short run and long run, they tend to produce the product at the minimum level of Average Total Cost(ATC).
- Monopolistic Competition: Firms under monopolistic firms are less productive inefficient than perfect competition as though in the long run, firms tend to earn normal profit by producing the product at P=ATC, however, they may never produce at the minimum of ATC.
- Monopoly: Since firms under monopoly face lack of competition, they do not have any incentive to increase their product and lower their costs.
- Oligopoly: Since firms under oligopoly continues to produce the product at price greater than Marginal Cost, they remain productive inefficient.
This form of efficiency is generated when the firm is successfully able to balance short term concerns and long term concerns.
- Monopolistic Competition: Firms operating under this kind of market structure has the most strongest incentive to engage in the product development as per latest R& D and technology.
- Monopoly: In terms of dynamic, monopoly firms ranks second and the only reason they might get involve in R& D in technological advancement is defensive, i.e. to reduce the risk of a new product or process that might destroy the monopoly.
- Oligopoly: Although oligopolist because of their large firm size, have the largest financial resource to engage in R&D, they are often complacent as they continues to enjoy barriers to entry into this market structure.
- Perfect Competition: Firm under perfect competition can never be dynamic because of zero economic profit even in the long run and small size of firms.
The lumber stores may not be successful at their cooperation because of the following reasons:
As the game theory model has proven that cooperation of different firms do not last long as each firm under the agreement is tempted to cheat so as to earn higher economic profit than the other firm in the agreement. To begin with let’s assume that Firm A and Firm B are two dominating firms operating under the oligopoly market structure. After competing over price and quantity for years, these two firms now enter into an agreement to reduce output and earn increased profits, however, soon both of these firms will not let their profit share reduce and in the urge to earn more profits, they enter into the game of Prisoner’s Dilemma where they will have possible outcomes:
- Each firm honors the agreement
- Both the firm cheats
- Firm A honors the agreement while the Firm B cheats
- Firm B honor the agreement while Firm A cheats
And further as suggested by the game theory, both the firm will cheat with the urge to higher economic profit. In this way, the lumber stores may turn unsuccessful at their cooperation.
ii) Disagreements – The firms under cooperation might lead to disagreements over various discussions as what is the best for the direction of their collusion and this may turn cooperation among them difficult. For Instance, some firms may expect demand to increase, while other may disagree and vote for the capacity to remain same.
iii) Poor economic conditions: Recessions are said to be the enemies of the collusion among firms as under such economic conditions, even firms under collusion might not be able to generate high sales leading to excess supply in the market by them. Thus, each firm will try to avoid profit reductions after cutting prices and thus they will gain sale at expense of rivals.
ii) Even if the firm turns to be successful on their collusion, there major concern will be the legal barriers. In other words, may countries have already passed Anti-Trust laws that prohibit the firms to collude and fix higher prices and many other are on the discussion to do so. Thus, even if the firms under collusion turn out to be successful, they will be declared unlawful as per their respective country’s law.
As a part of discussing the product differentiation and their effect on consumers, we will be discussing the advertisements of various toothpastes in the market:
The product claims to whiten the teeth and ensures fresh breath for long lasting period
The product claims to strengthen the gums of the user.
The product claims to end sensitivity to the cold water or ice-creams on teeth.
Amway Glister Toothpaste:
The product claims to whiten the teeth and builds resistance from germs for 12 continuous hours.
Impact on customer and future impact on industry:
With each toothpaste brand offering different product differentiation, there is no doubt that each of them will benefit the consumer in the form of healthy teeth and gums. Important to note that will multiple factors of product differentiation introduced by the toothpaste brand, we can expect that anyone of them or a new brand might come with all the health benefits in just one toothpaste.
i)Organization of Petroleum Exporting Countries(OPEC), play a major role in determining the gas prices around the world. It is a consortium of 13 countries which includes: Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. These countries accounts for 40% of the world’s oil production. Thus, whenever, OPEC wants to raise the price of crude oil, it simply cuts the oil production as it did in April 2011 when the per day production of oil was reduced by one million barrel per day. At that moment, the average price of gas was increased to $1.71 per gallon. Similarly, when OPEC wants to reduce the oil prices, it increases the oil supply. For Instance, during June 2005, OPEC raised the production to 28 million barrels per day, thus leading to reduction in price levels.
ii) Here the reference by OPEC regarding its disability to enforce the internal production targets are the direct reason for the over production of oil. OPEC which regulates its production in order to influence the global crude prices, largely depend on its members who are asked to follow the production regulation so as to avoid any sudden change in oil prices in respect to excess or low supply. However, any violation of these internal production targets by the OPEC members largely affects the oil supply in the world.
The reason of countries refraining from oil supply might indicate about their strategy to create oil reserves for the futures when oil prices might surge again.
Allocative Efficiency. 26 June 2014 <http://www.economicshelp.org/blog/glossary/allocative-efficiency/>.
Herron, James. OPEC Hamstrung by Events Beyond Its Control. 17 June 2012. 26 June 2014 <http://online.wsj.com/news/articles/SB10001424052702303734204577467893480636270>.
Max, Billy. Toothpaste Marketing Strategies. 26 June 2014 <http://smallbusiness.chron.com/toothpaste-marketing-strategies-68241.html>.
Obstacles to collusion. 26 June 2014 <http://justdan93.wordpress.com/2012/08/02/obstacles-to-collusion/>.