Allocative inefficiency is observed in the case of monopoly where economies of scale is absent. Define the allocative inefficiency and present a diagram which shows allocative inefficiency of profit-maximizing monopoly. Compare the price and profit maximization level of output of monopoly to those of a perfectly competitive market. For comparison’s sake, use the assumption that firms in a perfectly competitive industry were bought by a business person and begins to act as a monopoly.

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Perfect Competition

It is the structure of the market that is said to exist when with many buyers and sellers exchanging similar commodities and its price is fixed by the market forces, demand, and supply, and a single firm cannot cause an impact over the price or market value of the homogenous product. This structure of the market is called perfect competition.