Chapter 19: Pure competition and economic efficiency
Perfect competition can be used as a yardstick to compare with other market structures because it
displays high levels of economic efficiency.
1. Allocative efficiency: In both the short and long run in perfect competition we find that
price is equal to marginal cost (P=MC) and thus allocative efficiency is achieved. At the
ruling market price, consumer and producer surplus are maximised. No one can be made
better off without making some other agent at least as worse off – i.e. the conditions are
in place for a Pareto optimum allocation of resources.
2. Productive efficiency: Productive efficiency occurs when the equilibrium output is
produced with average cost at a minimum. This is not achieved in the short run, but is
attained in the long run equilibrium for a perfectly competitive market.
3. Dynamic efficiency: We assume that a perfectly competitive market produces
homogeneous products – in other words, there is little scope for innovation designed
purely to make products differentiated from each other and thereby allow a supplier to
develop and then exploit a competitive advantage in the market to establish some
Some economists claim that perfect competition is not an optimal market structure for high
levels of research and development spending and the resulting product and process innovations.
Indeed it may be the case that monopolistic or oligopolistic markets are more effective in
creating the environment for research and innovation to flourish. A cost-reducing innovation
from one producer will, under the assumption of perfect information, be immediately and
without cost transferred to all of the other suppliers.
That said, a “competitive market” (i.e. a contestable market) provides the discipline on firms to
keep their costs under control, to seek to minimise wastage of scarce resources and to refrain
from exploiting the consumer by setting high prices and enjoying high profit margins. In this
sense, a more competitive market can stimulate improvements in both static and dynamic
efficiency over time. It is certainly one of the main themes running through the recent toughening-up of UK and Europea