Types Of Efficiency Flashcards
What is allocative efficiency?
When Price = MC and the marginal benefit to the consumer equates to the marginal cost of the supplier and social surplus is maximised
Causes Of Allocative Efficiency
Perfect Competition (firms are price takers hence consumer sovereignty) and if P>MC, new firms enter as there are no barriers to entry (increasing supply) and reduce the price
Absence Of Market Distortions
No taxes, subsidies, price controls and externalities (market reflects true costs and benefits)
Consequences Of Allocative Efficiency
Optimal Resource Allocation
Consumer and Producer Surplus Maximised
Society Receives Highest Possible Utility
What is productive efficiency?
When costs per output levels are minimised
MC = AC
Firms are minimising waste and cannot produce more of one good without produce less of another (Pareto Efficiency In Production) and edge of PPF curve
Causes Of Productive Efficiency
Perfect Competition (firms must minimise costs to survive
Economies Of Scale (Large Scale Production lowers per unit costs e.g Bulk Buying and Specialisation)
Technological Advancements (Better Machinery, Automation and processes reduce Production Costs)
Consequences Of Productive Efficiency
Lower Costs -> Lower Prices for consumers (Key in competitive markets)
Higher Profits if prices remain stable (can be used for R&D investment)
Efficient Firms can outcompete rivals domestically and internationally
What is dynamic efficiency?
A firms ability to reduce its average cost in the future
When firms improve technology, innovation and productivity
Emphasises Future Gains from R&D and Technological progress and product innovation
Causes Of Dynamic Efficiency
Competitive Markets (firms innovate to outpace rivals)
High Profits and Investment in R&D
Government Support (Tax breaks and subsidies for R&D)
International Competition pressures firms to innovate
Consequences Of Dynamic Efficiency
Lower Costs and Higher Quality Overtime (innovation can reduce production costs)
Economic Growth (new Industries emerge such as AI and Biotechnology)
Higher productivity means that the economy is producing at a greater level which increases GDP per Capita which increases living standards and individual utility
Better products and lower costs can be passed onto consumers with lower prices in a competitive market - leads to increased consumer utility
Sustainable Development (e.g Green Technology) which reduces environmental harm
BUT…
SHORT TERM COSTS
RISK OF FAILURE
What is X-inefficiency?
When a firm fails to minimise its production costs, stemming from internal waste
Causes Of X-Inefficiency
Lack Of Competition means firm face no pressure to cut costs as the risk of another firm entering and producing at a lower cost is low (especially if there are high barriers to entry)
Poor Management Practices (bureaucracy, rigid hierarchies, misaligned incentives)
Principal Agent Problem - Managers may prioritise perks/job security over cost cutting
Labour Inefficiencies - Overstaffing and Low worker motivation can cause workers to produce less, reducing output per cost levels
Government Protection can shield firms from market discipline
Consequences of X-Inefficiency
Higher Costs cause Higher Prices
Wasted resources cause the firms to fail to meet potential profit levels, reducing shareholder returns
Lack of profits reduce the ability of a firm being able to re-invest profits into R&D, reducing dynamic efficiency
Firms lose global competitiveness
