3.4.1 Efficiency

What are efficiencies?

Efficiencies can be used to judge how well the market allocates resources, and the relationship between scarce inputs and outputs

Allocative efficiency

• Achieved when resources are used to produce the goods and services which consumers want and value most highly, and where social welfare is maximised

• Occurs when the value to society from consumption is equal to the marginal cost of production (P=MC)

Productive efficiency

• Achieved when products are produced at the lowest average cost, so fewest resources are used to produce the maximum output

• Only happens if firms produce at bottom of ATC curve, where MC=ATC

Dynamic efficiency

• Achieved when resources are allocated efficiently over time - usually where competition encourages innovation and investment

• Only possible if there is supernormal profits to provide firms with the incentive to invest

X-inefficiency

• A type of productive inefficiency - when a firm fails to minimise its average costs at a given level of output (not producing at lowest point on ATC curve)

• Usually when there is a lack of competition, so firms are not incentivised to cut costs