Efficiencies

Question 1

Allocative efficiency

Answer 1

Allocative efficiency occurs when consumers pay a market price that reflects the private marginal cost of production. The condition for allocative efficiency for a firm is to produce an output where marginal cost, MC, just equals price, P. If the marginal cost was £10, and people were only willing to pay £5 for the good (at output 5), this is allocatively inefficient.

Question 2

Productive efficiency

Answer 2

Productive efficiency is concerned with producing goods and services with the optimal combination of inputs to produce maximum output for the minimum cost. To be productively efficient means the economy must be producing on its production possibility frontier. (i.e. it is impossible to produce more of one good without producing less of another).
Productive efficiency is closely related to the concept of Technical Efficiency. A firm is technically efficient when it combines the optimal combination of labour and capital to produce a good. i.e. cannot produce more of a good, without more inputs.

Question 3

Productive efficiency diagrams

Answer 3

Points A and B are productively efficient. Point C is inefficient because you could produce more goods or services with no opportunity cost
A firm is said to be productively efficient when it is producing at the lowest point on the average cost curve (where Marginal cost meets average cost).

Question 4

X efficiency

Answer 4

X Inefficiency occurs when a firm has little incentive to control costs (e.g not finding cheapest suppliers). This causes the average cost of production to be higher than necessary. When there is this lack of incentives, the firm will not be technically efficient. E.g state controlled firms with no profit incentive, or monopoly’s making easy supernormal profits.

Question 5

Dynamic efficiency

Answer 5

Dynamic efficiency is concerned with the productive efficiency of a firm over a period of time. A firm which is dynamically efficient will be reducing its cost curves by implement new production processes. Dynamic Efficiency will enable a reduction in both SRAC and LRAC. Improved by investment in technology, r&d, capital (trade off as it costs in short run).
For example, in 1923, Henry Ford’s car factory was one of the most efficient firms in the world. But, by today’s standards that same car factory would be left far behind. Therefore dynamic efficiency is concerned with the optimal rate of innovation and investment to improve production processes which help to reduce the long run average cost curves.

Question 6

Static efficiency

Answer 6

Static efficiency is concerned with the most efficient combination of resources at a given point in time. For example, static efficiency involves the concept of productive efficiency – producing at the lowest point on the short run average cost curve – given existing resources and factor inputs.