Efficiency Concepts Flashcards
Explain static efficiency.
Static efficiency refers to efficiency at a given point in time. Assuming constant technology, it focuses on how Mich output can be produced from a given stock of resources.
Explain how economic efficiency is achieved.
Economic efficiency is attained by achieving both productive and allocative efficiency.
Explain how dynamic efficiency is achieved. Explain how dynamic efficiency can be boosted.
Dynamic efficiency results from improvements in technology that occur over time. It is defined as the situation whereby firms are technologically progressive and invest in R&D, the human capital of the workforce, in order to reduce average COP and meet the changing, wants and needs of consumers over time.
Dynamic efficiency can be boosted by:
1) R&D spending that leads to improvements in products and the production process.
2) Investment in the human capital of the workforce, leading to gains in productivity and in product quality (vital in high value-adding knowledge-based sectors).
3) Greater competitive pressures in markets and the transfer of knowledge and ideas across sectors/countries.
This depends on the financial ability of the firm which is in turn determined by its LR profits. The higher the existing and potential competition, the greater its incentive to innovate and invest but willingness does not always mean that the firm is able to do so. With less competition, firms that enjoy LR supernormal profits may not also be willing to innovate.
Explain how is equity achieved.
Equity includes the fairness of distribution in wealth, income, opportunities and profits (equal distribution or distribution based on need). The idea of equitable distribution is a normative one as it involves value judgement.
Explain how is consumer choice achieved.
Consumers are given the freedom to choose from a variety of goods and services as well as to purchase similar goods from different producers.
Define allocative efficiency.
Allocative efficiency is achieved when society produces and consumes a combination of goods and services that maximizes society’s welfare. (goods and services produced in the right quantities)
State the three instances when allocative efficiency is achieved.
It is achieved when:
1) Society produces at a particular point that maximises its social welfare on the PPC.
2) P = MC
3) MSB = MSC
Define productive efficiency.
Productive efficiency is achieved when all the resources are fully and efficiently utilised and the cost of producing at a given level of output is minimized.
State the three instances where productive efficiency is achieved.
Productive efficiency is achieved when:
1) Society produces at any point on the PPC
2) A firm produces at any point on its LRAC curve
3) (From society’s point of view) firm produces at the lowest point of its LRAC/ the MES
This is because competition between firms keeps costs down. In the pursuit of self-interest, firms aim to maximise profits. The more cost-efficient they are, the higher their profits would be, ceteris paribus. Hence, the profit motive incentivises firms to be productively efficient, that is to minimise wastage and to keep unit costs of production as low as possible.
Explain how the free market may lead to an efficient allocation of resources - explain why allocative efficiency is achieved when both consumer and producer surplus are maximised.
Using the DD/SS framework, the free market economy allocates resources according to the market forces of demand and supply. Assuming perfect competition and the absence of sources of market failure, the equilibrium quantity where supply equals demand represents the allocatively efficient level of output. This is because the DD curve which represents consumers’ valuation of the good (measured and shown by the maximum prices they are willing and able to pay at any quantity) reflects consumers’ additional utility or MPB derived from purchasing the last unit of the good. In the pursuit of self-interest, utility-maximising consumers will only consumer an additional unit of the good if the MPB from consumption exceeds the price that they have to pay. Hence they will consume up the point where MPB from consumption equals price at Q0 where consumer surplus is maximised. On the other hand, the SS curve which reflects producers marginal cost of producing the additional unit of corn shows the additional opportunity cost to producers in terms of the resources used* in producing that last unit of the good and the minimum price accepted by producers. In the pursuit of self-interest, profit-maximising producers will produce an additional unit of the good as long as MPC is less than the price they receive from selling the good. Hence they will produce up to the point where MPC equals to price at Q0 and producer surplus is maximised. Hence, allocative efficiency is achieved when the sum of consumers surplus and producer surplus is maximised.
Explain how the free market may lead to an efficient allocation of resources - explain why allocative efficiency is achieved when P = MC.
P = MC is where society’s valuation of the last unit of output produced is equal to the opportunity cost of producing it.
Explain how the free market may lead to an efficient allocation of resources - explain why allocative efficiency is achieved when MSB = MSC.
MSB = MSC where the additional benefits society gets from the last unit of good produced equals the additional opportunity cost that the society incurs from producing it.
