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IAI Actuarial Core Principles · Business Economics · How competitive markets operate

Why is a perfectly competitive market in long-run equilibrium described as allocatively efficient?

A competitive market is allocatively efficient because price equals marginal cost. Price measures the marginal benefit to consumers, so the value of the last unit to buyers equals the cost of making it, and total surplus is maximised with no deadweight loss.

  1. AFirms produce at the lowest point of their marginal cost curve
  2. BPrice equals marginal cost, so the marginal benefit to consumers equals the marginal cost of productionCorrect
  3. CAll firms earn supernormal profit that is redistributed to consumers
  4. DProducer surplus is maximised at the expense of consumer surplus
  5. Price is set above marginal cost to cover fixed costs

Explanation

Price reflects the marginal benefit to consumers and, for competitive firms, price equals marginal cost. Resources are therefore allocated so that no reallocation can raise total surplus. Option 0 confuses this with productive efficiency, and option 2 is wrong since long-run profit is normal.

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