Economic Efficiency

Definition of efficiency

Efficiency is concerned with the optimal production and distribution of scarce

resources.

Different types of efficiency

• Productive – producing for the lowest cost.

• Allocative – distributing resources according to consumer
preference P=MC
• Dynamic – Efficiency over time.
• X-efficiency – incentives to cut costs.
• Efficiency of scale – taking advantage of economies of scale.
• Social efficiency – taking into account external costs/benefits.

1. Productive efficiency

This occurs when the maximum number of goods and services are produced
with a given amount of inputs. This will occur on the production possibility
frontier. On the curve, it is impossible to produce more goods without
producing fewer services. Productive efficiency will also occur at the lowest
point on the firm’s average costs curve. (Q1)
2. Allocative efficiency

This occurs when goods and services are distributed according to consumer
preferences. An economy could be productively efficient but produce goods
people don’t need this would be allocative inefficient.

Allocative efficiency occurs when the price of the good = the MC of

production. This occurs at an output of 80, where price £11 = MC.

At an output of 40, The price of £15 is much greater than MC of £6 – there is

underconsumption.
3. X inefficiency
This occurs when firms do not have incentives to cut costs, for example, a
monopoly which makes supernormal profits may have little incentive to get rid
of surplus labour.

If a firm’s average costs are higher than potential – then we are x-inefficient.
4. Efficiency of scale

This occurs when the firms produce on the lowest point of its long-run average
cost (Q2) and therefore benefits fully from economies of scale
5. Dynamic efficiency
This refers to efficiency over time, for example, a Ford factory in 2010 may be
very efficient for the time period, but by 2017, it could have lost this relative
advantage and by comparison, would now be inefficient. Dynamic efficiency
involves the introduction of new technology and working practices to reduce
costs over time.

• Dynamic efficiency
• Static efficiency – efficiency at a particular point in time.
6. Social efficiency
This occurs when externalities are taken into consideration and occurs at an
output where the social cost of production (SMC) = the social benefit (SMB)

Social efficiency occurs at an output of 16 – where SMB = SMC

7. Technical efficiency
This requires the optimum combination of factor inputs to produce a good: it is
related to productive efficiency.
8. Pareto efficiency

A situation where resources are distributed in the most efficient way. It is

defined as a situation where it is not possible to make one party better off
without making another party worse off.

9. Distributive efficiency
Concerned with allocating goods and services according to who needs them
most. Therefore, requires an equitable distribution.

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