Unit 3

Kno-how! on efficiency

Efficiency

Background Reading:

Nutter A2 micro book (2nd ed) p. 67-70

Student Unit Guide (old ed / new ed) p.18 / p.12

Students should be able to:

Understand that a market is productively efficient when

output is produced at lowest possible average cost.

Understand that a market is allocatively efficient when

output is produced at a price paid by consumers that is

equal to the marginal cost incurred in producing that

output

What is Economic Efficiency?

There are limited resources available to

produce the goods & services to satisfy

our wants such as, for example, our

insatiable demands for healthcare.

Economic efficiency is about finding the

best or optimal way to satisfy most

wants or at least the most important

wants.

Types of Efficiency

Static

Productive

Allocative

Dynamic

Technical

X-efficiency

Pareto

Social

Static Efficiency

Most A2 economic analysis is about

static efficiency, eg how much output

can be produced from our resources at

any one point of time.

Productive Efficiency

Minimising the unit cost of any quantity

of output.

As a result of scarcity, productive

efficiency implies minimum resources

(land, labour and capital used up in

production, leaving more for other uses.

Profit motive also encourages productive

efficiency because profit is revenue

minus costs.

Productive Efficiency

MC = AC diagram here

Productive Efficiency

MC = AC

Productive Efficiency

Productive Efficiency means exploiting

all potential internal economies of scale

Can also be achieved through

re-organisation (e.g. to cell production),

investment in new technology,

training for staff

Allocative Efficiency

Students should be able to:

Understand that a market is allocatively

efficient when output is produced at a

price paid by consumers that is equal to

the marginal cost incurred in producing

that output

4.6 Allocative Efficiency

Market forces should ensure that the prices that

consumers will pay reflect the benefits

(satisfaction / utility) they expect from

consumption (law of equi-marginal returns).

Most consumers gain a surplus, with the

consumer deriving just enough marginal benefit

(MU) from the last unit consumed to justify

paying the price (AR) which should cover the

marginal cost of production (MC).

Thus the benefit (MU or AR or price) justifies the

cost in terms of resources used up.

4.6 Allocative Efficiency

MC = AR DJ MC is AR Allocator

Remember AR = PRICE and PRICE = MU

MC (the cost of the resources used to generate the

good/service) = AR or p or MU the value placed on

the product by the buyer.

Allocative Efficiency

Dynamic Efficiency

Dynamic efficiency occurs in a market over time and is concerned with the effects of investment and improvement of operations. A dynamically efficient firm may invest more profit back into R&D, staff training and new equipment rather than dividend payments. This might reduce future costs and increase future profits.

Technical Efficiency

Productive efficiency requires technical

efficiency whereby, at a given quantity of

output, the combination of factors of

production used minimises inputs.

Which is the appropriate short-run cost

curve (combination of factors of

production) that is appropriate for that

level of output.

See PJV’s fishing example.

Technical Efficiency

Other types of efficiency - X – inefficiency

X – inefficiency

how far from being (productively &

allocatively) efficient a firm is because the

market situation they are in (such as

monopoly) does not provide enough

incentives to become more efficient.

See section of regulation of privatised

monopolies.

Other types of efficiency – Pareto efficiency

Pareto efficiency

A situation where no one economic agent

can be made better off without making

another worse off.

Other types of efficiency – Distributive

efficiency

Distributive efficiency

A situation where goods produced are

distributed precisely to those desiring

them.

Other types of efficiency – Social efficiency

Occurs where social marginal benefit = social marginal cost.

Differs from private or internal costs and benefits due to externalities (see unit 2)

Issues for evaluation

Allocative efficiency ignores

distribution issues (willingness to pay is based on

income as well.)

market failure

factor immobility

less than perfect markets where price > marginal

cost.