12.7 : Supply and Demand, and Efficiency in a Perfectly Competitive Market I

In a perfectly competitive market, efficiency is achieved when total surplus, the sum of consumer and producer surplus, is maximized. Consumer surplus represents the benefit consumers receive from purchasing a product at a price lower than what they are willing to pay, while producer surplus reflects the benefit producers gain from selling at a price higher than their minimum acceptable price.

When production decreases, the quantity available in the market falls. With fewer goods available, some consumers who were previously able to buy at lower prices are now priced out of the market. This reduction in quantity means that some consumers, who are willing to pay a higher price, remain in the market, while others, who were previously able to purchase the product at a lower price, are no longer able to do so. This reduction in production limits the number of consumers who can participate in the market. A portion of the consumer surplus is transferred to the producer surplus. However, the total surplus declines.

A quantity lower than the equilibrium quantity leads to underproduction. So, consumers willing to pay more than the marginal cost are unable to buy the product. This reduction in market activity results in a loss of total surplus. Efficiency means maximizing total surplus. If the quantity moves away from equilibrium, efficiency decreases. For example, underproduction reduces total economic welfare.