3.4.1 Efficiency

Question 1

Efficiency

Answer 1

Can be used to judge how well the market allocates resources, and the relationship between scarce inputs and outputs. There are a range of different types of efficiency: allocative, productive, dynamic and x-inefficiency.

Question 2

Allocative efficiency (PRICES)

Answer 2

This is 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 value to society from consumption is equal to the marginal cost of production, where P=MC.

Question 3

Productive efficiency (COSTS)

Answer 3

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. (The minimum resources are used to produce the maximum output.)
This can only exist if 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- but not all technically efficient firms are productively efficient.

Question 4

Dynamic efficiency (PROFIT)

Answer 4

This is achieved when resources are allocated efficiently over time. It is concerned with investment, which brings new products and new production techniques.
- (The alternative is static efficiency: efficiency at a set point in time. Allocative and productive efficiency are examples of static efficiency.)
Dynamic efficiency will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws. Supernormal profit is required to provide firms with the incentive to invest and the ability to do so.

Question 5

X-efficiency (type of productive efficiency)

Answer 5

If a firm fails to minimise its average costs at a given level of output, it is X-inefficient and there is organisational slack. This is a specific type of productive inefficiency as it occurs when they fail to minimise their cost for that specific output.
For example, the minimum point on the AC curve may be at 100 goods at a cost of £5 each.
The firm is producing 125 goods and so is not productively efficient.
It costs them £8 to produce each good, but they could produce 125 goods at £7. Therefore, they are X-inefficient since they are not producing on the lowest AC curve. It often occurs where there is a lack of competition so firms have little incentive to cut costs.