profits are maximized by producing at the quantity where price is equal to marginal cost, they are thus

ensuring that the social benefits they receive from producing a good are in line with the social costs of

production.

To explore what economists mean by allocative efficiency, it is useful to walk through an example. Begin by

assuming that the market for wholesale flowers is perfectly competitive, and so P = MC. Now, consider what it

would mean if firms in that market produced a lesser quantity of flowers. At a lesser quantity, marginal costs

will not yet have increased as much, so that price will exceed marginal cost; that is, P > MC. In that situation,

the benefit to society as a whole of producing additional goods, as measured by the willingness of consumers

to pay for marginal units of a good, would be higher than the cost of the inputs of labor and physical capital

needed to produce the marginal good. In other words, the gains to society as a whole from producing
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