Question 1

Can a firm be productively efficient but not allocatively efficient?

Accepted Answer

Yes, this is a common scenario. A profit-maximising monopoly, for instance, may achieve productive efficiency by producing its output at the lowest possible average cost. However, it will restrict output and set a price significantly higher than its marginal cost (P > MC) to maximise profits. This violates the condition for allocative efficiency, meaning consumers are not getting the quantity of the good they desire at a price that reflects its production cost.

Question 2

Does market failure always mean the government should intervene?

Accepted Answer

Not necessarily. While market failure provides a strong justification for government intervention, the intervention itself might not lead to a better outcome. 'Government failure' can occur, where intervention leads to a worse allocation of resources than the free market. This can be due to imperfect information, political self-interest, high administrative costs, or unintended consequences. Therefore, the potential for government failure must be weighed against the severity of the market failure.

Question 3

Is deadweight loss just a transfer of wealth from consumers to producers?

Accepted Answer

No, this is a critical misconception. A transfer of wealth, for example when a monopoly raises its price, involves consumer surplus being converted into producer surplus (profit). A deadweight loss, however, is a net loss to society as a whole. It is potential consumer and producer surplus that simply vanishes – it is not captured by anyone. It represents transactions that would have been beneficial for both buyer and seller but did not occur due to market inefficiency.

Efficiency and market failure

What you need to know

Efficiency and market failure