In a perfectly competitive market, efficiency is achieved when total surplus, the sum of consumer and producer surplus, is maximized. This occurs at the equilibrium level, where supply equals demand.
If production increases beyond this equilibrium level, the marginal cost increases as output rises. The perfectly competitive model assumes that producers continue increasing output until their marginal cost equals the market price. If the market price exceeds equilibrium, producers supply more than consumers demand at that price, leading to surplus inventories. This surplus exerts downward pressure on prices, encouraging higher consumer demand and pushing the market toward equilibrium. As a result, the total surplus decreases.
Any change in supply that moves the quantity away from the equilibrium quantity reduces economic efficiency and results in deadweight loss. Both overproduction and underproduction result in a loss of total surplus, demonstrating that equilibrium maximizes surplus.
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