Allocative Efficiency Vs Productive Efficiency
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Jojo YeeAllocative Efficiency Vs Productive Efficiency
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Jojo YeeEfficiency under Perfect Competition
Productive efficiency
Productive efficiency occurs when a firm is combining resources in such a way as to
produce a given output at the lowest possible average total cost. So, nothing is going to
waste. Costs will be minimized at the lowest point on a firm's short run average total
cost curve.
This also means that ATC = MC, because MC always cuts ATC at the lowest point on
the ATC curve. ATC = MC = Price
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. Markets are
working in most efficient manner and there are no externalities – no over or under
production of goods and services. It is more concerned with the distribution and
allocation of resources in society.
The condition for allocative efficiency for a firm is to produce an output where marginal
cost, MC, just equals price, P. MC = P
Monopolies are often said to be allocatively inefficient because they are able to set the
price higher than marginal cost. See: Monopoly
Which is most important productive or allocative efficiency?
There would be no point in being productively efficient if all resources are diverted to
making guns. We could be producing on a production possibility frontier but, if it is all
guns, society would not have enough food or health care.
An anecdote from the Soviet Union under Communist days tells how factories were
given targets to produce certain quantities of goods. They often did this with great
vigour and were productively efficient, but, often they were producing goods which
weren’t needed by society. There is a story that one factory made left-hand boots that
nobody wanted, so at the end of the day they would efficiently burn them and the next
day start again! They were productively efficient but not allocatively efficient.
However, productive efficiency is still important. If goods are produced at a lower cost it
enables society to have a better trade-off and enable the scope for people to consume
more goods and services.
Can we have allocative efficiency without productive efficiency?
Firms could produce products that people need and that would maximize marginal
benefit. However, due to a variety of reasons the firms may not be efficient in producing
these products. Some reasons include X-inefficiency (in the case of big firms),
managerial problems, and wage problems.
In a Nutshell
Most economic issues arise because of scarce resources. Hence, it is critical to use,
produce and distribute those resources in an efficient manner. There are a number of
different types of economic efficiency. The five most relevant ones are: allocative,
productive, dynamic, social and X-efficiency. Allocative efficiency occurs when goods and
services are distributed according to consumer preferences. Productive efficiency is a
situation where the optimal combination of inputs results in the maximum amount of
output. Dynamic efficiency occurs over time, as innovation reduces production
costs. Social Efficiency happens when goods and services are optimally distributed, also
taking externalities into account. And last but not least, X-efficiency occurs when a firm
has an incentive to produce maximum output with a given amount of input.