Efficiency in Market Structures

Idea

The government’s microeconomic goals are efficiency and equity. Efficiency has three standard forms — productive, allocative and dynamic — and the market structures differ systematically in how well they meet them.

Mechanism

• Perfect competition. Firms produce at the lowest point of the long-run average cost curve, so they are productively efficient.

• Monopolistic competition. Firms earning only normal profit in the long run can never be productively efficient, because they do not exhaust all internal economies of scale at their profit-maximising output.

• Oligopoly and monopoly. Firms earning supernormal profit in the long run may achieve productive efficiency, but only by chance — if their profit-maximising output happens to coincide with the minimum efficient scale.

Considerations

The comparison is genuinely two-sided, which is what makes it useful for evaluation. Firms with market power tend to fall short on static (productive and allocative) efficiency and are prone to x-inefficiency where weak competition dulls the incentive to control costs. Yet the same firms, funded by supernormal profit and protected by barriers to entry, are often better placed to achieve dynamic efficiency through research and development, and to reap large economies of scale. Whether a structure is judged “good” therefore depends on which efficiency is weighted, and on how efficiency is traded against equity.