What is economic efficiency?

Economic efficiency means the using of resources in such a way as to maximize the production of goods and services. Economic efficiency exists when

  • No one can be made better off without making someone else worse off.
  • More output cannot be obtained without increasing the amount of inputs.
  • Production proceeds at the lowest possible per-unit cost.

Also referred to as 'Pareto Optimality'

Named after the economist Vilfredo Pareto, an economy is in a Pareto Optimal state when no further changes in the economy can make one person better off without at the same time making another worse off.

There are two requisites in order to achieve economic efficiency or Pareto Optimality. These are

Productive efficiency

It is achieved when production of goods is achieved at the lowest cost possible.
Look at the PPC diagram below. Point X shows Productive inefficiency. This is because the output is not optimum and there are still resources left unused. Whereas, Point Y shows productive efficiency, as this is the maximum output which can be achieved through the utilizing all resources.

productive efficiency diagram

In long-run equilibrium for perfectly competitive markets, this is where average cost is at the base on the Average Cost curve. (MC=AC). In the diagram below q is the point of productive efficiency.

productive efficiency and perfect competition

Allocative efficiency

Allocative efficiency is a situation in which the limited resources of a firm are allocated in accordance with the wishes of consumers. An allocatively efficient economy produces an "optimal mix" of commodities. In short, the products that are most wanted must be produced.
A competitive market can lead to Allocative efficiency because the firms are forced to produce what the customers want.


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