Explain what is meant when it is said that there are inefficiencies in the production of goods and the allocation of resources.

The economy achieves optimal allocation of resources when productive and allocative efficiency are attained: ·     Productive efficiency occurs when products are made using the least possible amount of scarce resources (in micro terms, the lowest point on the ATC curve, in macro terms, any point along the Productive Possibility Curve or PPC).·     Allocative efficiency occurs when the products that are most wanted are the ones being produced (in micro terms, the price the consumer is willing to pay equals the extra cost of producing an additional unit P=MC, in macro terms, this is an unknown point on the PPC). The market is not perfect and inefficiencies including under- and over- production and consumption; lack of provision of public goods; and problems associated to monopoly power often appear disrupting the optimal allocation of resources. 1.    Under- production and consumption occur due to positive externalities (external benefits to third parties) and merit goods (goods/services that are better for us than we realise them to be i.e. education). The market is inefficient because too few resources are devoted to their production, resulting in underproduction, and because of a lack of information, resulting in under consumption. Under these scenarios, the actual supply of a good is lower than the ideal supply of it or the demand is smaller than it should be, for under production and under consumption respectively. 2.    Over- production and consumption are a result of negative externalities (external costs to third parties) and demerit goods (goods/services that are worse for us than we realise them to be i.e. cigarettes). The market is inefficient because too many resources are devoted to their production, resulting in overproduction, or due to a lack of information, resulting in over consumption. Where there is overproduction actual supply is greater than the ideal supply. Where there is over consumption, demand for that good is greater than it should be. 3.    The lack of provision of public goods. These goods are extended to everyone at 0 cost (through tax collection), non-rejectable and non-excludable, and non-rival (the benefits the first consumer derives from the good/service are not diminished as more people consume it), consequently they suffer the problem of free ride. Consumers sit back and wait for someone else to produce the good and extend it to everyone else at 0 cost. This cycle of everyone waiting for everyone else results in the good never being provided in the free market economy. 4.    Problems derived from monopoly power. Monopolies are price makers and thus aim to maximise profits (MC=MR). Their problems can be seen when compared to the ideal perfect competition (PC) market situation. Firstly, prices imposed on consumers are much higher in a monopoly than in PC conditions (P_m > P_pc) leading to inefficiency since the consumer is worse off and exploited. Additionally, the quantity supplied in a monopoly is lower than that supplied in PC (Q_m < Q_pc) leading to another inefficiency since the economy is not making full use of resources under monopoly markets. Monopolies fail to achieve productive & allocative efficiency: it produces to the left of the technical efficiency point (minimum of the ATC curve) leading to spare capacity or inefficiency in the economy, and it achieves no allocative efficiency since P_m > P_Im (point where P = MC in a monopoly market). Finally, monopolies create a deadweight loss where consumer surplus is lost and turned into producer surplus in order to create an abnormal profit which it can maintain in the long-run due to its extensive barriers to entry and exit of the industry. Desirable levels of consumption and production do not take place in a monopoly, hence the optimal allocation of resources is not met.