Allocative and Productive Inefficiency

A question and answer on a 15 marker efficiency question.

"In august 2013, the UK government argued that there needed to be greater competition in energy markets in the UK"

Explain why a lack of competition is likely to lead to allocative and productive inefficiency in markets such as the market for energy. {15}

Productive efficiency is when a firm operates at its lowest point on the average cost curve. Allocative efficiency is when the price is equal to marginal cost or when there is a consumer surplus. A lack of competition can lead to x-inefficiencies  as there is no incentive to be competitive and keep costs low. Therefore firms would operate their costs above point A. As a result a firm may pass on the extra unnecessary cost onto the consumer as the firm may have some monopolistic power. As energy is generally a necessity in most peoples households, therefore the demand for energy is inelastic, thus consumers continue to buy the increased energy despite the price change. As a result the consumer has lost some of their consumer surplus/allocative efficiency. This may indicate that a lack of competition  can lead to allocative efficiency. Firms such as EDF have been known for passing on costs to consumers and reducing consumer surplus.

Also a lack of competition is likely to lead to productive inefficiency as firms are not taking advantage of economies of scale and may be operating on the economies of scale slope but have not reached point A where they are taking full advantage of economies of scale. If a firm is producing at an output of 100 and faces no competition, it is unlikely that they would undergo trying to take advantage of economies of scale as they may need to invest money into the factors of productions which may reduce supernormal profits in the short-term. Therefore firms would opt into staying at a point before point A on the average cost curve, as then they would receive a similar amount of supernormal profit.

This question got 12/15 marks and is a still a solid answer despite not getting full marks.

• Make sure that you use plenty of keywords like in the above essay. The more you use the more likely that your answer will be put in a higher level( meaning more marks!)
• Use lots of connectives to structure your work so it flows better.( Avoid words such as also as it can break up your chains of analysis)
• Also use plenty of your own economic knowledge ( examiners love this!!)
• And refer to the question constantly

I hope that this has been helpful and good luck in any upcoming exams :) !

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