Allocative efficiency is the market condition where the resources are allocated to their maximum benefits. A firm is allocatively efficient when its price is equal to its marginal costs (i.e.P = MC) in the perfect market.
Marginal benefit
The marginal benefit indicates in dollar terms what the consumer is willing to pay to acquire one more unit of the good and is related to the height of an individual’s demand curve.
Utility of each addition unit of a good consumed is lower than the previous one, known as diminishing marginal utility.
Marginal cost
The marginal cost is the cost of the next unit produced, also called opportunity cost.
MC=ΔTC/ΔQ
Efficient quantity
Efficient quantity of output occurs when mariginal cost equal to marginal benefit.
- When marginal benefit of a product is greater than its marginal cost, value will be created by producing more units of it.
- If the opposite applies, value will be created by producing less units instead and diverting more resources to other more highly valued goods.
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