3.4.1 Efficiency

Question 1

Allocative Efficiency:

Answer 1

> Achieved when resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised.
It will occur when the marginal benefit from consumption is the same as the marginal cost of production. Marginal benefit is shown by the demand curve.
P=MC

Question 2

Productive efficiency:

Answer 2

> A firm has productive efficiency when its products are produced at the lowest average cost so the fewest resources are used to produce each product.
Minimum resources are used to produce maximum output.
Can only exist of firms produce at the bottom of the AC curve. In the short-run this is where MC=AC.
It is only possible if there is technical efficiency, where a given output is produced with minimum inputs. Not all technically efficient firms are productively efficient.

Question 3

Dynamic Efficiency:

Answer 3

> Achieved when resources are allocated efficiently over time. It is concerned with investment which brings new products and production techniques.
The alternative is static efficiency, efficiency at a set point in time. Allocative and productive efficiency are static.
Dynamic efficiency is often achieved in markets where competition encourages innovation. Supernormal profit is usually required to incentivise a firm to invest and have the ability to do so.
Ideally long run average costs fall.

Question 4

X-Inefficiency:

Answer 4

> If a firm fails to minimise its average costs at a given level of output, it is X-inefficient.
E.g. the minimum point on the AC curve may be 100 units at a cost of £5 each. The firm is producing 125 goods so is not productively efficient. It costs them £8 each to produce each, but it could cost them £7 each to produce 125.
They are therefore X-inefficient because they are not producing on the lowest AC curve. They are above the level of technical efficiency.
Often occur due to a lack of competition so firms have little incentive to cut costs.