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Allocative efficiency occurs when an industry provides the greatest amount of consumer satisfaction that is possible given the available resources. Allocative efficiency is possible only in perfect competition.
This is true because perfect competition is the only market structure in which firms produce at a price where there is no economic profit. In other structures, this does not happen. In those other market structures, economic profit is taken, too few goods are produced, and too high of a price is charged.
So, in perfect competition, firms can enter the market and drive prices down and production up to the point where allocative efficiency is achieved.
Allocative efficiency in economics refers to the situation when the society is using its resources in a way that maximises the sum of utilities derived by all the people in the society. Under such a condition it no reorganization of production in the society will make anyone better off without making someone worse off. This means that increase in one person's benefits or satisfaction can be achieved by a matching or higher reduction in someone else's utility or satisfaction.
One condition necessary for existence of allocative efficiency is that the product mix of the economy is on the production-possibility-frontier. Forther these goods produced must be allocated to diferent consumers to maximize their total satisfaction.
By definition of allocative efficiency it is not necessary that it can occur only under condition of perfect monopoly.We can assume that perfect competition automatically results in allocative efficiency, only when there are no externalities like pollution, and the distribution of income under competitive market is accepted as fair.
The first determination one must make is what perfect competition constitutes. Perfect competition exists when there are many small operations in a market that produce uniform or homogeneous goods. It is a market structure that is not very likely to exist. For pure competition to exist there are several factors that must occur: There needs to be many small businesses producing goods with no one business over dominating the market; all firms must be able to make a profit; the businesses must be able to ebb and flow with the market; and consumers must be made aware of various products, who supplies them, and the cost of the products.
This having been said, one must be made aware that businesses operate on the value of profit based on supply and demand and reallocation of funds and resources. When looking at prices and their curve in the market one must also look at the expenses and consumption of resources to produce the goods. Price is equal to marginal costs or the formula (P=MC). In order for allocative efficiency to be met in perfect competition, the price of an object can be produced at the minimal or average cost.
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