Market competition and its affects

Question 1

When market competition is present, how is the efficiency of resource allocation affected

Answer 1

• Competitive markets are characterised by: low barriers of entry, similar products, many buyers and sellers
• Similar products means producers must compete on price
• Profit motivated producers must reduce cost per unit in order to increase profit
• This can be achieved by increasing innovation or productivity (Increased outputs for given inputs)
• Thus productive efficiency (minimising inputs for given outputs) is achieved

Question 2

How is allocative efficiency affected by market competition

Answer 2

• in more competitive markets, due to consumer sovereignty, profit motivated producers respond to price signals and allocate resources to which product has the highest relative price
• This ensures that the more demanded product is made available to consumers who desire it, reducing shortages and surplus
• Allocative efficiency is then achieved as the production point is maximising the benefit to society
• Prices are also lowered as competition encourages firms to lower price to attract rational consumers, thus the living standards of consumers is also improved.