There are several meanings of the term - but they
generally relate to how well an economy allocates scarce resources to meets
the needs and wants of consumers.
Static efficiency exists at
a point in time and focuses on how much output can be produced now from a
given stock of resources and whether producers are charging a price to
consumers that fairly reflects the cost of the factors of production used to
produce a good or a service. There are two main types of static efficiency,
allocative and productive.
Allocative efficiency is
achieved when the value consumers place on a good or service (reflected in
the price they are willing to pay) equals the cost of the resources used up
in production. Allocative efficiency occurs when price = marginal cost, when
this condition is satisfied, total economic welfare is maximised.
allocative efficiency as a situation where no one could be made better off
without making someone else at least as worth off.
In perfect competition
allocative efficiency is achieved as output takes place where price is equal
to marginal cost, this is shown below.
Under monopoly, a business can keep price above marginal
cost and increase total revenue and profits as a result, this is shown below.
Assuming that a monopolist and a competitive firm have
the same costs, the welfare loss under monopoly is shown by a deadweight loss
of consumer and producer surplus compared to the competitive price and
output. This is shown in the diagram below.
The previous diagram allows
us to state that society would be better off under perfect competition rather
than monopoly, as monopoly leads to a higher price and a lower level of
output. This is also reflected
in the deadweight welfare loss.
This can also be
illustrated using a production possibility frontier - all points that lie on
the PPF can be said to be allocatively efficiency because we cannot produce
more of one product without affecting the amount of all other products
available. Point A is allocatively efficient - but at B we can increase
production of both goods by making fuller use of existing resources or
increasing the efficiency of production.
refers to a firm's costs of production and can be applied both to the short
and long run. It is achieved when the output is produced at minimum average
total cost (AC). For example we might consider whether a business is
producing close to the low point of its long run average total cost curve.
When this happens the firm is exploiting most of the available economies of
scale. Productive efficiency exists when producers minimise the wastage of
resources in their production processes.
Under perfect competition,
the firm produces at the lowest point on the AC curve in the long run,
thereby being productively efficient.
Under monopoly, however, the presence of barriers of
entry allow the monopolist to earn abnormal profits in the long run.
The monopolist is not forced to operate at the lowest point on the AC
curve. The monopolist is
therefore unlikely to be productively efficient (unlike the firm in perfect
Efficiency And Equity
There is often a trade-off between economic efficiency
and equity. Efficiency means that all goods or services are allocated to
someone (there’s none left over). When a market equilibrium is efficient,
there is no way to reallocate the good or service without hurting someone.
Equity concerns the distribution of resources and is inevitably linked with
concepts of fairness and social justice. A market may have achieved maximum
efficiency but we may be concerned that the "benefits" from market
activity are unfairly shared out.
The socially efficient level of output and or
consumption occurs when social marginal benefit = social marginal cost. At
this point we maximise social economic welfare. The presence of externalities
means that the private optimum level of consumption / production often
differs from the social optimum.
In the diagram above the social optimum level of output
occurs where social marginal cost = social marginal benefit (point B). A
private producer not taking into account the negative production
externalities might choose to maximise their own profits at point A (where
private marginal cost = private marginal benefit). This divergence between
private and social costs of production can lead to market failure.