Economic efficiency is a general term in economics describing how well a system
is performing, in generating the maximum desired output for given inputs with available technology. Efficiency is improved if more output is generated without changing inputs, or in other words, the amount of "friction" or "waste" is reduced.
Economic efficiency is used to refer to a number of related concepts. A system can be called economically efficient if:
- No one can be made better off without making someone else worse off. (lipsey)
- More output cannot be obtained without increasing the amount of inputs.
- Production proceeds at the lowest possible per unit cost.
Economic efficiency can be seen in various types but two will be examined in the context. The two are namely:
Ø Productive efficiency.
Ø Allocative efficiency.
Productive efficiency
This occurs when the economy is operating at its production possibility frontier (PPF).Given this it must be true that productive efficiency can only exist when an economy is producing right on the boundary of its production possibility frontier.
y
Producer goods x
Consumer goods
(Productive efficiency in an economy)
This further takes place when production of one good is achieved at the lowest cost possible, given the production of the other good(s). Equivalently, it is when the highest possible output of one good is produced, given the production level of the other good(s). In long-run equilibrium for perfectly competitive markets, this is where average cost is at the lowest point on the Average Cost curve. (MC=AC)
Due to the nature of monopolistic companies, they will choose to produce at profit maximizing levels (where MC=MR) and therefore will not be productively efficient as the lowest average cost would not produce enough profit for the company. However, due to economies of scale it can become possible for monopolistic companies to produce at MC=MR with a lower price to the consumer than perfectly competitive company’s producing at MC=AC.
Allocative efficiency
This refers to a situation in which the limited resources of a country are allocated in accordance with the wishes of consumers. An allocatively efficient economy produces an "optimal mix" of commodities. A firm is allocatively efficient when its price is equal to its marginal costs (that is, P = MC) in a perfect market.
Marginal cost
Average cost
P Average revenue=marginal revenue