Efficiency

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Efficiency can be separated into static efficiency and dynamic efficiency.

Dynamic efficiency refers to how efficient a system is over time. It looks at how productivity changes over time.
For dynamic efficiency to be achieved, normally some supernormal profits must be made in the long run. This is because firms need to reinvest profits.

X-inefficiency happens when monopolies do not feel the need to reinvest their profits to improve their efficiency.
So, they do not produce at their lowest possible cost.
Causes of X-inefficiency include:
- Inefficient use of factors of production.
- Overpaying for factors of production.

Conditions for Efficiency

There are conditions that have to be met for efficiency to be achieved.

Allocative efficiency happens when the benefit gained from the extra unit of the good is equal to the price of it.
So allocative efficiency happens when the marginal utility the consumer gains is equal to the price.
Or when the marginal cost of producing the good is equal to the price.
Allocative efficiency can also be shown by an economy operating at a point on (but not inside) its PPF.

Dynamic efficiency is changed by factors that affect productivity and improve factors of production.
- E.g investment in human capital might increase the output per worker over time. This is an increase in dynamic efficiency.
Technological change can lead to new processes that are more efficient.
- So, this is a cause of dynamic efficiency.

The characteristics of a particular market will dictate output, price and the distribution of surplus and welfare.

Perfect competition is seen as the ideal situation for consumers, at least in the short run.
In perfect competition, no supplier can affect the market price and market quantity of the good or services they produce.
There are no barriers to entry or exit. Every consumer that can pay the market price is able to consume the good or service.

In a free market a monopolist will look to maximise profits and without competition can do that at the point where marginal costs = marginal revenue. This is at a higher price and lower quantity than there would be in a competitive market.
Consumer surplus is lower than in a perfectly competitive market.
But if there are few barriers to entry, then there is an incentive to enter the market and the price could fall. Competitors could reduce prices or innovate to produce a cheaper or better product, which would be good for consumers.

Natural monopolies are markets where it is efficient to have either only one provider or one major provider. These are usually markets where there are disproportionately high fixed costs leading to significant economies of scale.
The incumbent in a natural monopoly is at a significant advantage over smaller competitors and potential entrants due to their much lower average costs due to economies of scale.
Because of this, the threat of competition is weak. If competitors entered, because firms would all have higher costs, this may actually be bad for consumers. Prices are higher and consumer surplus lower at lower quantities of output.

If an oligopoly is competitive firms will compete somewhat on price and product.
The firms are incentivised to invest in research and development which leads to continuous innovation in both product and production further lowering prices and improving quality.
The mobile phone industry is a prime example (Apple, Samsung etc). A small number of large competitive firms who continually work to offer the best product.
In these markets, quantity is higher and price lower than in a monopoly. But consumer surplus is usually lower than in a perfectly competitive market.
In the long-run, the innovation enabled by supernormal profits may make welfare higher, because the market is more dynamically efficient.

Oligopolies can also be uncompetitive and act like monopolies. - With a small number of firms in the market it is easier to collaborate and collude either explicitly or tacitly. When they collude, firms set prices and output so that the firms share the monopoly profit.
To the consumer, the market can be indistinguishable from a monopoly with higher prices, lower quantity therefore lower surplus and welfare compared to a perfectly competitive market.

Monopolistic competition is where firms are selling unique products but are competing over the same customers.
Each firm has a degree of monopoly power which they earn through providing differentiated products and building their brand.
With differentiated products, consumers face more choice potentially satisfying more wants and needs.