Sunday, February 6, 2011

Why P=MC is Efficient

Students often have trouble understanding the efficiency condition, P=MC.  Maybe students would understand the concept if they used consumer's surplus to measure utility.  If you need a review of consumer's surplus, click here.  Assume, the P>MC.  The size of consumer's surplus will be smaller than when P=MC.  If you assume that economic actors seek to maximize utility, then the actions of consumers and producers will result in a condition that maximizes utility.  In order for utility to be maxed, P must equal MC, an efficient outcome.

In monopolized markets P>MC so utility is not maximized.  That means that resources that are used in the monopolized market could have alternate uses in a perfectly competitive market that would lead to a greater consumer's surplus and greater utility.  That's why monopolies are inefficient from society's viewpoint.

About the Author: Mike Fladien is a high school Economics and Law teacher in Muscatine, Iowa. He has been called the EconHacker because he has a talent for explaining Economics concepts in a simple language that anyone can understand.

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