Allocative Efficiency and Welfare Loss
Market Failure: Market Power
AO3·AO4·Diagram required·HL
Syllabus requirement
In perfect competition, efficiency occurs where P = MC. In imperfect markets, welfare loss arises due to restricted output and higher prices.
Assessment objectives
AO3 Synthesis and EvaluationAO4 Use of Appropriate Skills
Required diagram: Diagram showing market equilibrium under perfect competition (P = MC) and comparison with monopoly (AR > MC) to highlight welfare loss.
Higher LevelThis topic is assessed at HL.
Summary
This topic compares allocative efficiency in perfect competition with the outcome under monopoly and explains the resulting welfare loss. It shows that allocative efficiency occurs when price equals marginal cost (P = MC or MSB = MSC) and describes how monopolies set price above marginal cost (P = AR > MC), restrict output and create a loss of social surplus. The topic also covers productive efficiency, natural monopolies and possible benefits of monopolies such as economies of scale and funding for R&D.
