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The Price Mechanism Can Be Relied Upon the Provide Efficiency

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Submitted By crampy123
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‘The Price Mechanism Can Be Relied Upon To Provide Efficiency’

I will first discuss this in very simple terms concerning such matters as the law of supply and demand. I will then present the situations in which inefficient results are created and also areas in which Pareto efficiency is of particular significance.
Generally, if the demand for a good increases its price will increase as supply becomes limited for consumers. This in turn acts as an incentive for producers to supply higher output and as supply increases the price will eventually go down and equilibrium will be achieved. This also works for the opposite as demand falls. In addition to this, in a perfectly competitive market firms will aim to produce where marginal revenue (MR) equals marginal cost (MC). This creates efficiency because if marginal revenue is higher than marginal cost then consumers are worse off because they are being charged high prices and thus rival competitors will take advantage with a lower supply price. On the other hand, if marginal cost is higher than marginal revenue then the firm is not using their resources efficiently as each additional unit incurs a marginal net cost. The only exception to this would be if the point at which MR is equal to MC was lower than the average cost (AC) curve, since the marginal revenue would not even cover the average cost. Therefore, we can see how the law of supply and demand and the result of a perfectly competitive market allows the price mechanism to create an efficient market.
This idea of perfect competition is a contrast to the world of monopolies where the price mechanism creates a particularly inefficient system. Simply, if there is no competition then there is no need for monopolies to lower their cost of production. Then, if their cost of production is relatively high they will be inclined to charge a higher price than at which...

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