Question

Explain why only a competitive and well-behaved market can guarantee an efficient outcome. In your answer discuss three factors that undermine a market’s ability to guarantee an efficient outcome.

Answer 1

Competitive Market can guarantee an efficienct outcome. Competitive market leads to maximum possible output. It produces where Price is equal to Marginal cost of production. Firm earns only zero economic profits. Consumer surplus is maximized here. Further, there is no expenditure on advertisements etc. Firm operates at the lowest point of AC in long run.

Following factors undermine market ability to guarantee effcient outcome:

• Externalities: These may be positive or negative. Hence, also may be under or over in such cases.
• Monopoly: Monopoly in market also compromises efficiency.
• In case of public goods, market does not work efficiently. Demand and supply forces do not reflect true demands for public goods.