Efficiency and the Relationship between Price & Marginal Costs

Efficiency

Productive Efficiency - goods are produced in the least costly way.

Allocative Efficiency – where the right amount (according to society) is produced.

Allocative Efficiency  P = MC , MC = P

·       Money price is society’s measure of the relative worth of the unit.  (price is the benefit)

·       An additional unit of a products value must include what could possibly have been made (opportunity cost)

If price is equal to marginal cost then the right goods (according to society) are being produced. 

Under-allocation  P > MC , MC < P

If price is more than the marginal cost there is an underproduction of goods (society wants more). Society values more of what is being produced than what could alternatively be produced with the same resources.

Over-allocation P < MC , MC > P

If price is less than marginal cost there is an overproduction of goods (society wants less). Society values what could be produced alternatively than how the resources are being presently used.

Notice, that the price is the same as Demand and Price are the same for Perfect Competition. 

• Quantity of production (output) is what you should focus on,,, as we produce more (Q3) than the price consumers are willing to pay or marginal costs increase quickly. We are overproducing in relation to the price. 
• If the price (quantity produced at that price, Q1) is above our marginal costs we are not at an allocatively efficient quantity,, we are underproducing.