Economics 9708/32 — May/June 2021

Background Concept

Allocative efficiency is achieved when resources are distributed in a way that maximizes net social benefit. For a firm, this occurs where the marginal benefit to consumers (represented by the price they are willing to pay, i.e., the Average Revenue or Demand curve) equals the marginal cost of producing that last unit (Marginal Cost). The condition is therefore AR = MC (or P = MC). Productive efficiency, by contrast, occurs when a firm produces at the lowest possible average cost, which is where the Marginal Cost curve intersects the Average Cost curve at its minimum point (MC = AC). In a monopolistically competitive market, firms face a downward-sloping demand curve and typically operate with excess capacity, meaning they are neither allocatively nor productively efficient in the long run.

Understanding the Question

The question asks to identify the point on a diagram of a monopolistically competitive firm that represents allocative efficiency. The diagram provides four curves (D=AR, MR, AC, MC) and four marked points (A, B, C, D), three of which (B, C, D) are clustered tightly together near the AC curve's minimum.

Approach

1. Recall the definition of allocative efficiency: AR = MC.
2. Identify which curves form each of the closely-spaced points B, C and D by tracing each line's direction into and out of the cluster.
3. Locate the AR × MC intersection specifically, distinguishing it from AC × MC (productive efficiency) and AC × AR (normal profit).

Step-by-Step Reasoning

• Point A is the intersection of MR and MC, away from the cluster. This is the profit-maximizing output level for the firm.
• In the B/C/D cluster, the AC curve is the smooth, gently curved line that runs through the lower two points (B and D), consistent with it being close to its minimum there.
• One straight line enters the cluster from the lower-left (this is MC, rising throughout the diagram) and exits to the upper-right toward the "MC" label. It touches the AC curve at the lower-left point of the cluster — point B — before continuing up to point C. So B = MC ∩ AC, the productive-efficiency point (minimum AC).
• The other straight line enters the cluster from the upper-left (this is AR, declining throughout the diagram, labelled "D=AR") and exits to the lower-right. It touches the AC curve at the lower-right point of the cluster — point D — after crossing through C. So D = AR ∩ AC, the point where price equals average cost (normal profit only, not allocative efficiency).
• The two straight lines, MC and AR, cross each other at the topmost point of the cluster — point C. Since price (AR) equals marginal cost (MC) exactly at C, this is the allocative efficiency point.
• Therefore, the correct point representing allocative efficiency is C.

Key Takeaways

• Allocative efficiency: AR = MC (Point C in this diagram).
• Productive efficiency: MC = AC at minimum AC (Point B in this diagram).
• AR = AC (normal profit, zero economic profit): Point D in this diagram — easy to mistake for allocative efficiency because it also sits on the AC curve.
• Profit maximization: MR = MC (Point A).

Common Mistakes

• Confusing allocative efficiency (AR = MC) with the AR = AC normal-profit point, especially when both lie close together on/near the AC curve, as at points C and D here.
• Assuming the point where a curve "touches" AC is always the allocative-efficiency point — AC touches both MC (at B) and AR (at D), neither of which is where MC = AR.
• Not tracing each line's slope carefully enough through a tightly clustered set of points; the direction a line enters and leaves the cluster identifies which curve it belongs to.

Things to Be Careful About

• When points are drawn very close together, trace each straight line's slope through the whole diagram (back to its axis label) rather than judging by proximity alone.
• Always double check exam diagrams directly — an auto-generated or assumed description of "point D = MC∩AR" can be wrong; here the real diagram shows C = MC∩AR and D = AR∩AC.