Powered by Leeds Metropolitan University
Economics Resources Economics revision notesEconomics revision quizzes Popular resources on the Economics blog Resource tags for the blog RSS Feed for the blog Twitter feed for the Economics blog Teacher Email Resource Newsletter Category listing for this blog AS / A2 Economics Blog Home Page

Economic efficiency

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Efficiency is about a society making optimal use of scarce resources to satisfy wants & needs

There are several meanings of efficiency but they all link to how well a market allocates our scarce resources to satisfy consumers

Normally the market mechanism is good at allocating these inputs, but there are occasions when the market can fail

Allocative efficiency

Allocative efficiency is concerned with whether we are producing the goods and services that match our changing needs and preferences and which we place the greatest value on

Allocative efficiency is reached when no one can be made better off without making someone else worse off. This is also known as Pareto efficiency

Allocative efficiency

Allocative efficiency occurs when the value that consumers place on a good or service (reflected in the price they are willing and able to pay) equals the cost of the resources used up in production.

The condition required for allocative efficiency is that price = marginal cost of supply.

In the diagram above, the market is in equilibrium at price P1 and output Q1. At this point, the total area of consumer and producer surplus is maximised. If for example, suppliers were able to restrict output to Q2 and hike the market price up to P2, sellers would gain extra producer surplus by widening their profit margins, but there also would be an even greater loss of consumer surplus. Thus P2 is not an allocative efficient allocation of resources for this market whereas P1, the market equilibrium price is deemed to be allocative efficient.

We will see when we study the economics of monopoly that when businesses have ‘pricing power’ in their own markets, they may increase their profit margins to squeeze extra profit from consumers (they are turning consumer surplus into producer surplus). This has an effect on allocative efficiency for if a monopoly supplier can select a price well above the costs of supply, consumers will suffer a reduction in their welfare. Have you ever felt ripped off buying sandwiches from a motorway service station? The producer has become better off but someone else has become worse off.

Using the production possibility frontier to show allocative efficiency

Pareto defined allocative efficiency as a position “where no one could be made better off without making someone else at least as worth off.”

This can be illustrated using a production possibility frontier – all points that lie on the PPF are allocatively efficient because we cannot produce more of one product without affecting the amount of all other products available

In the diagram below, the combination of output shown by Point A is allocatively efficient as is the combination shown at point B – but at the output combination C we can increase production of both goods by making fuller use of existing resources or increasing efficiency.  C represents a loss of economic efficiency.

Loss of economic efficiency

 

If an economy is operating within the PPF there will be an under-utilisation of resources causing output of goods and services to be lower than is feasible.

In this sense unemployment is a waste of scare resources; indeed the hours lost through jobless workers can never be recovered – unemployment can be costly from both an economic and social viewpoint.

If every market in the economy is a competitive free market, the resulting equilibrium throughout the economy will be Pareto-efficient.

 Productive Efficiency

  • Productive efficiency is achieved when the output is produced at minimum average total cost
  • Productive efficiency exists when producers minimise the wastage of resources in their production processes.

Dynamic Efficiency

  • Dynamic efficiency occurs over time and it focuses on changes in the amount of consumer choice available in markets together with the quality of goods and services available.

Social Efficiency

  • The socially efficient level of output and or consumption occurs when marginal social benefit = marginal social cost. At this point we have maximized social welfare.
  • The existence of negative and positive externalities means that the private optimum level of consumption or production often differs from the social optimum leading to some form of market failure and a loss of social welfare.
  • The price mechanism does not always take into account social costs and benefits of production

In the diagram below the socially optimum level of output occurs where the social cost of production (i.e. the private cost of the producer plus the external costs arising from externality effects) equals demand

A private producer who ignores the negative production externalities might choose to maximise their own profits at point A. This divergence between private and social costs of production can lead to market failure

Allocative efficiency

 





Add your comments and share this study note:

blog comments powered by Disqus

 

Search tutor2u






Order by 


Related study notes

Buy your personal copy of our Economics revision guides

tutor2u Economics Revision Guides

Agriculture
Behavioural Economics
Network Economics
Game Theory
Business Economics
Economics of Utilities
Contestable Markets
Competitive Markets
Economies of Scale
Management Issues
Monopolistic Competition
Monopoly
Oligopoly
Price Discrimination
Competition Policy
Commodities Markets
Emerging Economies
Human Development
African Economy
South African Economy
Kenyan Economy
Development Economics
Brazil Economy
China Economy
Indian economy
Russia Economy
Cost Benefit Analysis
Cycles and Shocks
Aggregate Demand
Capital Investment
Consumer Spending
Saving
Aggregate Supply
Demography
Economic History
Economic Growth
Competitiveness
Innovation
Economics of Technology
Environmental Economics
European Economy
EU Enlargement
EU Farming and Fishing
Single Market
The Euro
Exchange Rates
Money and Finance
Monetarism
Global Economy
IMF
Balance of Payments
Credit Crunch
International Trade
Housing Economics
Government Intervention
Buffer Stocks
Government Failure
Indirect Taxes
Maximum Prices
Minimum Prices
Regulation
Subsidies
Health Economics
Inflation and Deflation
Labour Market
Trade Unions
Introductory Economics
Macroeconomic Policies
Fiscal Policy
Monetary Policy
Supply-side policies
Trade Policies
Keynesian Economics
Market Failure
Externalities
Factor Immobility
Information Failure
Merit & De-Merit Goods
Public Goods
Manufacturing Industry
Oil and Gas
OECD Economies
Australia Economy
French Economy
German Economy
Greece Economy
Ireland Economy
Japan Economy
Poland
Spain Economy
US Economy
Poverty and Inequality
Market Equilibrium and Price
Elasticity of Demand
Elasticity of Supply
Nature of Demand
Nature of Supply
Price Mechanism in Action
Price Volatility
Inter-related Markets
Standard of Living
Transport Economics
UK Economy
Regional Economics
London Economy
Recession Watch
Unemployment

 


TBBLE - the Best Business Lesson Ever 2013

tutor2u

Tutor2u support for students
Teaching support and resources
Search for resources on tutor2u

Law



Refine Search by Subject
A Level Economics
Business Studies
Geography Give It A Go!
History Law
IB Diploma Politics
Religious Studies Sociology

Order Search Results By


Follow tutor2u on Twitter
   
   

tutor2u Home Page | Online Store | About tutor2u | Copyright Info | Your Privacy | Terms of Use

tutor2u

Working with Our Partners

 Zondle - Games for LearningVue Cinemas | Moneypenny | Nexcess | Really Simple Systems 

Boston House | 214 High Street | Boston Spa | West Yorkshire | LS23 6AD | Tel +44 0844 800 0085 | Fax +44 01937 529236

Company Registration Number: 04489574 | VAT Reg No 816865400

tutor2u is proud to sponsor TABS Cricket Club and the Wetherby Cricket League as part of its commitment to invest in local junior sport