, economic efficiency
is, roughly speaking, a situation in which nothing can be improved without something else being hurt. Depending on the context, it is usually one of the following two related concepts:
These definitions are not equivalent: a market
or other economic system
may be allocatively but not productively efficient, or productively but not allocatively efficient. There are also other
definitions and measures. All characterizations of economic efficiency are encompassed by the more general engineering
concept that a system is efficient
when it maximizes desired outputs (such as utility
) given available inputs.
Standards of thought
There are two main standards of thought on economic efficiency, which respectively emphasize the distortions
created by governments
(and reduced by decreasing
government involvement) and the distortions
created by markets
(and reduced by increasing government involvement). These are at times competing, at times complementary—either debating the overall
level of government involvement, or the effects of specific
government involvement. Broadly speaking, this dialog takes place in the context of economic liberalism
, though these terms are also used more narrowly to refer to particular views, especially advocating laissez faire.
Further, there are differences in views on microeconomic versus macroeconomic efficiency, some advocating a greater role for government in one sphere or the other.
Allocative and productive efficiency
A market can be said to have allocative efficiency
if the price of a product that the market is supplying is equal to the marginal value
consumers place on it, and equals marginal cost
. In other words, when every good or service is produced up to the point where one more unit provides a marginal benefit
to consumers less than the marginal cost of producing it.
Because productive resources are scarce
, the resources must be allocated to various industries in just the right amounts, otherwise too much or too little output gets produced.
When drawing diagrams for businesses
, allocative efficiency is satisfied if output is produced at the point where marginal cost is equal to average revenue. This is the case for the long-run equilibrium
of perfect competition
occurs when units of goods are being supplied at the lowest possible average total cost
. When drawing diagrams for businesses, this condition is satisfied if the equilibrium is at the minimum point of the average total cost curve
. This is again the case for the long run equilibrium of perfect competition. For an extensive discussion of many other types of productive efficiency and its measures (Farrell, Hyperbolic, Directional, Cost, Revenue, Profit, Additive, etc.) and their relationships.
The first fundamental welfare theorem
provides some basis for the belief in efficiency of market economies, as it states that any perfectly competitive market equilibrium
is Pareto efficient
. The assumption of perfect competition means that this result is only valid in the absence of market imperfections
, which are significant in real markets.
Furthermore, Pareto efficiency is a minimal notion of optimality and does not necessarily result in a socially desirable distribution of resources, as it makes no statement about equality or the overall well-being of a society.
Schools of thought
Advocates of an expanded government role follow instead in alternative streams of progressivism; in the Anglosphere
(English-speaking countries, notably the United States, United Kingdom, Canada, Australia and New Zealand) this is associated with institutional economics
and, at the macroeconomic level, with Keynesian economics
. In Germany the guiding philosophy is Ordoliberalism
, in the Freiburg School
The theory of the second best
states that if there is some unavoidable market distortion in one sector, a move toward greater market perfection in another sector may actually decrease efficiency.
Economic efficiency can be characterized in many ways:
Applications of these principles include:
- ^ Thomas. Government Regulation of Business. 2013, McGraw-Hill.
- ^ Sickles, R., & Zelenyuk, V. (2019). Measurement of Productivity and Efficiency: Theory and Practice. Cambridge: Cambridge University Press. doi:10.1017/9781139565981
- ^ Economics, fourth edition, Alain Anderton, p281
- ^ Barr, N. (2004). Economics of the welfare state. New York, Oxford University Press (USA).
- ^ Sen, A. (1993). Markets and freedom: Achievements and limitations of the market mechanism in promoting individual freedoms. Oxford Economic Papers, 45(4), 519–541.
On the Concept of Efficiency, Prabhat Patnaik (1997), Economic and Political Weekly, October 25, 1997.
Last edited on 26 April 2021, at 04:44
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