Question

Discuss why a purely competitive industry is considered optimal. Discuss when a purely competitive industry may not provide the optimal allocation of scarce resources.

Answer 1

A purely competitive industry is considered optimal because it results in maximization of economic surplus that

ensures efficiency. There are allocative efficiency (minimum ATC is achieved) and productive efficiency ( P =

MC) which help in maintaining equilibrium in the market so that all those who are willing and able to buy the

product, actually buy it. Consumer surplus and producer surplus are maximized and thus, the result is optimal.

A purely competitive industry may not provide the optimal allocation of scarce resources in case where it

ignores the external cost / benefit of the market activity, such as in case of externality. Then there are common

resources and public goods where private market (competitive industry) fails to allocate these resources.