Microeconomic Principles

Running head: MICROECONOMIC PRINCIPLES
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Microeconomic Principles
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MICROECONOMIC PRINCIPLES
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Question 1
a.
When a producer apportions resources to the creation of products in a way that
culminates in the best outcome to the society, the producer is said to be allocative efficient.
Allocative efficiency happens when a firm produces at a point where the price is identical to the
marginal cost, that is, P = MC (Arnold, 2013). Under a perfectly competitive market, the
suppliers are allocative efficient because they run a point where the price is equivalent to the
marginal cost. On the graph below, a perfectly competitive firm generates a point A where the
price is equal to the marginal cost. This situation exhibits the occurrence of allocative efficiency
and that the resources are well apportioned for the advantage of the society.
Cost /
Revenue
Graph 1: Allocative efficiency in a perfectly competitive market
However, when a single seller is in the market, the condition of allocative efficient that
price matches the marginal cost is not accomplished (Deodhar, 2013). A single seller runs a
LMC
LAC
A P = MR =
AR
P*
Q*0 Output

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point where the price is higher than the marginal cost, that is, P > MC and hence it is allocative
inefficient. On the graph two below, a single seller runs at position U making a profit-
maximizing level of output Q. If a single seller was allocative efficient, then it produces
at position T creating allocative efficient output Q*. As a result, resources are
inefficiently allocated when there is only one producer in the market.
Revenue /
Cost
P V V
Graph 2: Allocative inefficiency under a single producer.
b. Advantages and Disadvantages of a single seller
A lower price is one of the benefits resulting from a single producer in the market. A single
seller such as a natural monopoly can enjoy economies of scale. Typically, economies of scale
results in a reduction in the cost of production. Such an advantage can be passed to the
purchasers through reduced prices (Hubbard, Garnett, Lewis, & O'Brien, 2016).
Furthermore, technological innovation is likely to occur when there is one seller in the market.
LMC
LAC
W
T
V
U
MR D
O Q
*
OutputQ*
Y

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New goods and services require producers to incur finances on research and development. Since
businesses with market power have higher chances of making positive economic profits, they can
utilize these earnings towards the development of new products.
Despite these benefits, a single seller in the market has some shortcomings. Foremost,
monopolies charge consumers higher prices and thus cause a reduction in consumer surplus, that
is, the gain a consumer receives from the marketplace (Kleindl, Burrow, & Dlabay, 2016). In
the absence of competitors, a monopoly will make products of lower quality and purchasers will
be forced to buy since there are no close alternatives.
Question 2
a. Perfectly competitive market
A perfectly competitive market structure is used a benchmark for allocative efficiency
because there are no hurdles to market entry or exit, both producers and buyers have perfect
knowledge about the market, established producers have no advantage over newcomers, and that
market prices reflect complete mobility of resources (Laibson & List, 2015). As a result, a
sellers in perfect competition market run at a point where the price balances the marginal cost,
that is, P = MC. This shows that alloacative efficiency is attained. On the figure three below, a
perfectly competitive vendor operates a point A where price is identical to marginal cost.
However, firms in other types of market structures, that is, oligopoly, monopoly, and
monopolistic competition the price surpasses the marginal cost, and hence they are allocative
inefficient.