Revision:Efficiency

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Productive efficiency

Productive efficiency is defined as the production of goods and services using the least possible scare resources or is achieved when a firm is producing at the lowest possible average cost. This is at the bottom of the average cost curve. Productive efficiency alone does not ensure economic efficiency.

Productive efficiency can be analyzed using three approaches- A firm's cost curve ( where productive efficiency is the point of technical efficiency or x-efficiency i.e the lowest point on the lowest average cost curve of the firm)

The second way of analyzing productive efficiency is through understanding it on a production possibility frontier or a production possibility curve (PPC). This curve shows the maximum production points of any combination of two goods e.g consumer and capital goods. Productive efficiency here would be when an economy is producing on the boundary of its PPC. Any production within the boundary of the PPC would imply inefficient use of resources in production of goods and services or spare capacity.

Finally, productive efficiency is obtain as a direct consequence of competition. Competition in general ensures that a firm produces goods and services at the minimum cost to maximize profits. Firms in a competitive market are hence compelled to produce using the least possible scare resources or be productively efficient lest they face possible bankruptcy. Perfect competition epitomizes the concept of productive efficiency as firms produce at the lowest point on their respective average cost curves at a point where AR=MR=P.

Productive efficiency along with allocative efficiency ensures economic efficiency and optimum resource allocation

Productive efficiency is achieved if and only if the firm is producing at the point where AC = MC.

Allocative efficiency

Allocative efficiency is the concept of producing goods and service using least possible scare resources that are most wanted or desired by consumers.

Allocative efficiency occurs when the marginal cost of producing a good is equal to the price of the good i.e. the price paid by consumers reflects the true economic cost of producing the good.

Allocative efficiency unlike productive efficiency cannot be illustrated on a PPC as the point of allocative efficiency may be at any point on the PPC and is entirely dependent on consumer preferences.

Competition ensures allocative efficiency as market-oriented businesses in a competitive market are forced to produces goods and services that are most demanded by consumers. Failure to do so would mean loss of business opportunities to rival firms and possible bankruptcy. A perfectly competitive market has production at the point where MC=P, which is an essential parameter for allocative efficiency.

Allocative efficiency

Allocative efficiency is achieved when the cost of producing a good is equal to the price consumers are willing to pay - this is how much the consumer values the good. At this point, welfare is maximised. Pareto optimality is achieved. No one can be made better off without making someone else worse off.

The condition for allocative efficiency is AR = MC (AR is equal to the price by definition).

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