Question

The disposable diaper industry is perfectly competitive. Which of the following is true? a. since the industry is perfectly competitive, price and quantity are at the socially efficient levels. b. Competitive price is higher and competitive quantity lower than the socially efficient point. c. Competitive price is higher and competitive quantity higher than the socially efficient point. d. Competitive price is lower and competitive quantity higher than the socially efficient point.

Short answer

In a perfectly competitive market, price and quantity are at the socially efficient levels, as the market price is equal to the marginal cost (P = MC), and the socially efficient point occurs when MC = P (MB). Thus, the correct answer is: a. since the industry is perfectly competitive, price and quantity are at the socially efficient levels.

Step-by-step solution

Understanding a Perfectly Competitive Market

A perfectly competitive market is characterized by the following: 1. Numerous sellers and buyers. 2. No barriers to entry or exit. 3. Homogenous products. 4. Perfect information among consumers and producers. In a perfectly competitive market, each firm is said to be a price taker. This means that the market price is given, and they have no control over their prices. The firms will produce up to the point where their marginal cost is equal to the market price because it is the most optimal production level.

Determining Socially Efficient Levels

A socially efficient outcome is achieved when the marginal cost (MC) equals the marginal benefit (MB). In a perfectly competitive market, the marginal benefit is represented by the market price (P), since consumers' willingness to pay directly reflects the value of the good for them. Socially efficient point occurs when MC = P (MB). Now, let's analyze each option:

Option A

"Since the industry is perfectly competitive, price and quantity are at the socially efficient levels." In a perfectly competitive market, the market price is equal to the marginal cost (P = MC). As we determined before, the socially efficient point is where MC = MB (P). Therefore, in a perfectly competitive market, price and quantity are at socially efficient levels. This statement is true.

Option B

"Competitive price is higher and competitive quantity lower than the socially efficient point." In a perfectly competitive market, the market price is equal to the socially efficient price (MC = P). Therefore, the competitive price can't be higher than the socially efficient point. The statement is false.

Option C

"Competitive price is higher and competitive quantity higher than the socially efficient point." As explained earlier, in a perfectly competitive market, the market price is equal to the socially efficient price (MC = P). The competitive price can't be higher. The statement is false.

Option D

"Competitive price is lower and competitive quantity higher than the socially efficient point." In a perfectly competitive market, the market price is equal to the socially efficient price (MC = P). Therefore, the competitive price can't be lower and the quantity higher than the socially efficient point. The statement is false. Based on the analysis of each option, the correct answer is: a. since the industry is perfectly competitive, price and quantity are at the socially efficient levels.

Key concepts

Social Efficiency

Social efficiency is an important concept in economics, especially in evaluating market outcomes. It describes a situation where resources in a market are allocated in the most beneficial way for society as a whole. This occurs when the goods are distributed such that the marginal cost equals the marginal benefit.
In a perfectly competitive market, social efficiency is naturally achieved because:

• The market price reflects the true value consumers place on a product, also known as marginal benefit.
• Firms produce at a level where the marginal cost is equal to this market price (price = marginal cost), ensuring every unit produced is valued by consumers at least as much as it costs to produce.

This means that the resources are being used in the most efficient manner, without any waste. Overall, the market works to maximize the net benefit to society.

Marginal Cost

Marginal cost is the cost of producing one additional unit of a product. It is a crucial concept because it affects decisions made by firms in a competitive market. When a firm decides how much to produce, it evaluates how the production of extra units will impact its total costs and revenues.
In a perfectly competitive market, each firm produces until:

• The market price equals the marginal cost.
• This is because producing where price = marginal cost is the point of profit maximization for firms. Beyond this, the cost of producing an extra unit exceeds the revenue it can generate.

Thus, marginal cost plays an essential role in aligning the interests of producers with social efficiency, as firms naturally operate where their marginal cost equals the marginal benefit to society.

Market Price

Market price in perfectly competitive markets is determined by the forces of supply and demand. A defining characteristic of these markets is that individual firms are price takers, meaning they accept the market price set by collective market conditions rather than setting their own prices.
Key factors to remember about market price include:

• It reflects the willingness of consumers to pay, and hence, the marginal benefit of the product.
• Firms produce where their marginal cost equals this market price, ensuring that the quantity supplied meets demand efficiently.

In essence, the market price ensures that all the coordinated actions in the market, from production to consumption, are socially efficient. Since it equates to marginal cost, goods are produced and consumed at the optimal level for society, minimizing waste and maximizing satisfaction.