Which of the following is likely to result in allocative inefficiency?

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Question restatement: Which of the following is likely to result in allocative inefficiency?

Option-by-option analysis:

- Option 1: A perfectly price-discriminating monopoly
  This scenario charges each unit a different price equal to the consumer’s willingness to pay, so the price paid for each unit is driven to the marginal benefit for that unit. In many cases this leads to price equaling marginal cost for each unit sold, which means the allocation can be allocatively efficient despite the monopoly extracting all surplus. Therefore, this option is not typically associated with allocative inefficiency; it is more about redistributing surplus to consumers versus the monopolist, but the overall quantity produced can still coincide with efficient levels. Hence, this statement would be incorrect as an answer to “likely to result in allocative inefficiency.”

- Option 2: A perfectly competitive market in long-run equilibrium with no externalities
  In perfect competition with no externalities, price equals marginal cost and resources are allocated efficiently. There is no DWL in this baseline model. Thus, this option does not reflect allocative inefficiency and is incorrect as the likely source of inefficiency.

- Option 3: An oligopoly market structure
  Oligopoly involves a few large firms with strategic interactions. They may collude or compete in ways that keep prices above marginal cost and restrict output relative to a competitive benchmark, creating deadweight loss. This is a classic source of allocative inefficiency because the quantity produced falls short of the socially optimal level, and price signals do not reflect the true marginal cost of production. This option is a strong candidate for the correct answer.

- Option 4: A monopsonist that faces a minimum wage where marginal revenue product equals the supply of labor
  In a monopsony, the employer has market power in hiring and typically employs less than the competitive output, paying a wage lower than the marginal product of labor. When a binding minimum wage is introduced, it can increase wages and potentially employment toward more efficient (competitive) levels, or, depending on the specifics, could still create deadweight loss if it reduces employment excessively. The scenario described is nuanced: it can reduce or eliminate DWL in some cases, but if the minimum wage is set such that employment falls or stays below the social optimum, it can still be allocatively inefficient. This option could be associated with inefficiency in certain configurations, but it is not as definitive as the oligopoly case in typical texts. Overall, it is not as straightforwardly linked to allocative inefficiency as Option 3, but it can be linked to inefficiency depending on the outcome.

- Option 5: A firm producing at the level of output where price is equal to marginal cost
  This is the textbook condition for productive–allocative efficiency in a competitive framework: P = MC means the value society places on the last unit produced equals the cost of producing it. This is the benchmark of allocative efficiency, not inefficiency. Therefore, this option would not be a source of allocative inefficiency.

In summary, most explanations point to oligopoly (Option 3) as the most likely source of allocative inefficiency due to price-setting power and output reduction relative to the socially optimal level. The other options describe conditions that are either allocatively efficient (Option 5), or describe scenarios where inefficiency is not the canonical outcome (Options 1, 2, and with caveats, 4).

AP Economics-Hillebrand AP Microeconomics Sem 1 Exam 2025 - Requires Respondus LockDown Browser

Which of the following is likely to result in allocative inefficiency?

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AP Economics-Hillebrand AP Microeconomics Sem 1 Exam 2025 - Requires Respondus LockDown Browser

Which of the following is likely to result in allocative inefficiency?

View Explanation

Log in for full answers

Similar Questions

Competition can be described and classified as monopolies, oligopolies, pure competition or as monopolistic competition. When it comes to how companies compete under these different situations, the following is true:

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