3.4.1 Efficiency

Question 1

What is allocative efficiency?

Answer 1

• achieved when resources are used to produce goods and services which consumers want and value most highly
• social welfare is maximised
• occurs when the value to society from consumption is equal to the marginal cost of production (P=MC)

Question 2

What is productive efficiency?

Answer 2

• when a firm’s products are produced at the lowest average cost so the fewest resources are used to produce each product
• minimum resources are used to produce maximum output
• can only exist if firms produce at the bottom of the AC curve
• in the short run this is where MC=AC

Question 3

What is dynamic efficiency?

Answer 3

• achieved when resources are allocated efficiently over time
• it is concerned with investment (which brings new products and new production techniques)

(The alternative is static efficiency: efficiency at a set point in time; e.g. allocative and productive efficiency)

• dynamic efficiency will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws
• supernormal profit is required to provide firms with the incentive to invest and the ability to do so

Question 4

What is X-inefficiency?

Answer 4

• if a firm fails to minimise its average costs at a given level of output, it is X-inefficient and there is organisational slack
• this is a specific type of productive inefficiency as it occurs when they fail to minimise their cost for that specific output
• e.g. the minimum point on the AC curve may be at 100 goods at a cost of £5 each. The firm is producing 125 goods and so is not productively efficient. It costs them £8 to produce each good, but they could produce 125 goods at £7. Therefore, they are X-inefficient since they are not producing on the lowest AC curve. It often occurs where there is a lack of competition so firms have little incentive to cut costs.