In microeconomics, economic efficiency is, roughly speaking, a situation in which nothing can be improved without something else being hurt. Depending on the context, it is usually one of the following two related concepts:
These definitions are not equivalent: a market or other economic system may be allocatively but not productively efficient, or productively but not allocatively efficient. There are also other definitions and measures. All characterizations of economic efficiency are encompassed by the more general engineering concept that a system is efficient or optimal when it maximizes desired outputs (such as utility) given available inputs.
Allocative efficiency is a state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing.
Pareto efficiency or Pareto optimality is a situation that cannot be modified so as to make any one individual or preference criterion better off without making at least one individual or preference criterion worse off. The concept is named after Vilfredo Pareto (1848–1923), Italian engineer and economist, who used the concept in his studies of economic efficiency and income distribution.
Productive efficiency (or production efficiency) is a situation in which the economy or an economic system (e.g., a firm, a bank, a hospital, an industry, a country, etc.) could not produce any more of one good without sacrificing production of another good and without improving the production technology. In other words, productive efficiency occurs when a good or a service is produced at the lowest possible cost. In simple terms, the concept is illustrated on a production possibility frontier (PPF), where all points on the curve are points of productive efficiency. An equilibrium may be productively efficient without being allocatively efficient— i.e. it may result in a distribution of goods where social welfare is not maximized. It is one type of economic efficiency.
An example PPF: points B, C and D are all productively efficient, but an economy at A would not be, because D involves more production of both goods. Point X cannot be achieved.
Productive efficiency occurs under competitive equilibrium at the minimum of average total cost for each good, such as the one shown here.
Productive efficiency of an industry requires that all firms operate using best-practice technological and managerial processes and that there is no further reallocation that bring more output with the same inputs and the same production technology. By improving these processes, an economy or business can extend its production possibility frontier outward, so that efficient production yields more output than previously.
Productive inefficiency, with the economy operating below its production possibilities frontier, can occur because the productive inputs physical capital and labor are underutilized—that is, some capital or labor is left sitting idle—or because these inputs are allocated in inappropriate combinations to the different industries that use them.
In long-run equilibrium for perfectly competitive markets, productive efficiency occurs at the base of the average total cost curve—i.e. where marginal cost equals average total cost—for each good.
Due to the nature and culture of monopolistic companies, they may not be productively efficient because of X-inefficiency, whereby companies operating in a monopoly have less of an incentive to maximize output due to lack of competition. However, due to economies of scale it can be possible for the profit-maximizing level of output of monopolistic companies to occur with a lower price to the consumer than perfectly competitive companies.
In microeconomics, economic efficiency, depending on the context, is usually one of the following two related concepts:
These definitions are not equivalent: a market or other economic system may be allocatively but not productively efficient, or productively but not allocatively efficient. There are also other definitions and measures. All characterizations of economic efficiency are encompassed by the more general engineering concept that a system is efficient or optimal when it maximizes desired outputs (such as utility) given available inputs.
Standards of thought
[
edit
]
There are two main standards of thought on economic efficiency, which respectively emphasize the distortions created by governments (and reduced by decreasing government involvement) and the distortions created by markets (and reduced by increasing government involvement). These are at times competing, at times complementary—either debating the overall level of government involvement, or the effects of specific government involvement. Broadly speaking, this dialog takes place in the context of economic liberalism or neoliberalism, though these terms are also used more narrowly to refer to particular views, especially advocating laissez faire.
Further, there are differences in views on microeconomic versus macroeconomic efficiency, some advocating a greater role for government in one sphere or the other.
Allocative and productive efficiency
[
edit
]
A market can be said to have allocative efficiency if the price of a product that the market is supplying is equal to the marginal value consumers place on it, and equals marginal cost. In other words, when every good or service is produced up to the point where one more unit provides a marginal benefit to consumers less than the marginal cost of producing it.
Because productive resources are scarce, the resources must be allocated to various industries in just the right amounts, otherwise too much or too little output gets produced.[1] When drawing diagrams for businesses, allocative efficiency is satisfied if output is produced at the point where marginal cost is equal to average revenue. This is the case for the long-run equilibrium of perfect competition.
Productive efficiency occurs when units of goods are being supplied at the lowest possible average total cost. When drawing diagrams for businesses, this condition is satisfied if the equilibrium is at the minimum point of the average total cost curve. This is again the case for the long run equilibrium of perfect competition. For an extensive discussion of many other types of productive efficiency and its measures (Farrell, Hyperbolic, Directional, Cost, Revenue, Profit, Additive, etc.) and their relationships.[2]
Mainstream views
[
edit
]
The mainstream view is that market economies are generally believed to be closer to efficient than other known alternatives[3] and that government involvement is necessary at the macroeconomic level (via fiscal policy and monetary policy) to counteract the economic cycle – following Keynesian economics. At the microeconomic level there is debate about how to achieve efficiency, with some advocating laissez-faire, to remove government distortions, while others advocate regulation, to reduce market failures and imperfections, particularly via internalizing externalities.[citation needed]
The first fundamental welfare theorem provides some basis for the belief in efficiency of market economies, as it states that any perfectly competitive market equilibrium is Pareto efficient. The assumption of perfect competition means that this result is only valid in the absence of market imperfections, which are significant in real markets.[citation needed] Furthermore, Pareto efficiency is a minimal notion of optimality and does not necessarily result in a socially desirable distribution of resources, as it makes no statement about equality or the overall well-being of a society.[4][5]
Schools of thought
[
edit
]
Advocates of limited government, in the form laissez-faire (little or no government role in the economy) follow from the 19th century philosophical tradition classical liberalism. They are particularly associated with the mainstream economic schools of classical economics (through the 1870s) and neoclassical economics (from the 1870s onwards), and with the heterodox Austrian school.
Advocates of an expanded government role follow instead in alternative streams of progressivism; in the Anglosphere (English-speaking countries, notably the United States, United Kingdom, Canada, Australia and New Zealand) this is associated with institutional economics and, at the macroeconomic level, with Keynesian economics. In Germany the guiding philosophy is Ordoliberalism, in the Freiburg School of economics.
Microeconomic reform
[
edit
]
Microeconomic reform is the implementation of policies that aim to reduce economic distortions via deregulation, and move toward economic efficiency. However, there is no clear theoretical basis for the belief that removing a market distortion will always increase economic efficiency.
The theory of the second best states that if there is some unavoidable market distortion in one sector, a move toward greater market perfection in another sector may actually decrease efficiency.
Criteria
[
edit
]
Economic efficiency can be characterized in many ways:
Applications of these principles include:
See also
[
edit
]
References
[
edit
]
Further reading
[
edit
]
The company is the world’s best ODM Electric Blanket Controller, OEM Personalized Electric Blanket, ODM Polar Fleece Electric Blankets supplier. We are your one-stop shop for all needs. Our staff are highly-specialized and will help you find the product you need.