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.