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Productive and Allocative Efficiency

Productive and Allocative Efficiency

  • Allocative efficiency: Maximizes consumer satisfaction in goods/services production; quantity supplied equals quantity demanded.
  • Productive efficiency: Maximum output from available factor inputs at the lowest average or unit cost.
  • Economic efficiency: Achieving both allocative and productive efficiency.
  • Average cost = total cost/output.
  • Economic efficiency: Maximum products produced at minimum cost, maximizing benefit to society.
  • Productive efficiency: Minimum inputs to produce maximum output at lowest cost.
  • Allocative efficiency: Producing goods to match consumer needs.

Productive Efficiency

  • Productive efficiency shown via average cost curve.
  • Average Total Cost (ATC) = total cost / output.
  • As output increases, costs per unit fall (fixed costs spread over higher output).
  • Productive efficiency occurs at output Q where average total costs are at their minimum.

Significance of the Margin

  • Firms make production choices based on the margin.
  • Choose options where marginal revenue > marginal cost (contributes to profits).
  • Marginal cost > marginal revenue = profits fall.
  • Produce until marginal cost = marginal revenue.

PPC and Efficiency

  • Any point on the Production Possibility Curve (PPC) = productively efficient.
  • On the curve = maximum production.
  • PPC shows trade-off between two variables (e.g., good X and good Y).
  • Opportunity cost: Producing more of one good means producing less of another.
  • Allocative efficiency: Depends on consumer preferences; found on PPC where consumer desires are met.

Achieving Allocative Efficiency

  • Difficult to identify; match consumer preferences to producer output (match demand and supply).
  • Markets don't always operate at market clearing price due to excess supply or demand.
  • Market forces push prices towards equilibrium (quantity demanded = quantity supplied).
  • Competitive markets help achieve allocative efficiency.

Increasing Productivity

  • Efficiency influenced by:
    • Increased technology use (e.g., automation) reduces average production costs.
    • Investment in human capital (training/education) reduces costs; improves output and productivity.
    • Improved management = better decisions, less waste, lower costs.

Minimum Efficient Scale (MES)

  • MES: Scale of production where long-run average cost curve is at its lowest point.
  • If MES occurs at low output levels relative to market size = many firms.
  • As MES increases = fewer firms (larger scale = lower long-run average costs).
  • Creates a barrier to entry for new, smaller firms.
  • Productive efficiency: No additional output from factor inputs at the lowest possible average cost.
  • Firm operating at the lowest point on the LRAC curve cannot produce more efficiently.

Market Orientation

  • Matching production to meet consumer preferences.
  • Outward-looking approach to new product development focused on consumer wants.
  • Informed by market research.
  • Firms focus on understanding consumer needs and adapting/producing products to meet them.
  • Reduces risk of new product development.