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Economics is all about efficiency. Most economic issues arise because of the scarcity of the resources. We have to find the best possible efficient ways for those resources, in term of use, produce and distribute. Different factors determine the efficiency of the situation, it is depending on the issue we are looking at. If resources are used in such way that maximizes the production of goods and services at the lower cost possible then it could be called an efficient market. An economy is considered more efficient when it produces more goods and services for the community than another by using the same or lower input. There are several ways of measuring of economy could be considered efficient recognized by economists, we will look at five of them in more detail below: allocative, productive, dynamic, social and X-efficiency.
Allocative Efficiency happens when all goods and services within an economy are distributed based on consumer desires which means, when the value of a society for particular good or service is in balance or equilibrium with the cost of the resources used to make it. The price should be always equal marginal cost of production. It could be stated that the price that the consumers are willing to pay for a product or service reflects the marginal utility they receive from consuming the product. Therefore, the optimum result is achieved when marginal cost (MC) equals marginal benefit (MB). This is illustrated in the following graphic.
The optimum result in the illustration is marked by point B (i.e. 240 units of output at a price of USD 120). This is at the intersection of the marginal cost curve and the marginal benefit curve. By contrast, point A does not represent an allocatively efficient outcome, because marginal cost of production does not equal marginal benefit at this point. It would be possible to find allocative efficiency in perfect competitive markets, because companies in perfect competitive markets don’t have enough market power to increase prices. To maintain their business, they should produce what society give value most, at the price which the customers are willing to pay. In contrast, it is claimed that monopolies produced inefficiently productive production levels simply because they have enough market power to influence prices and reduce consumer surplus.
Productive efficiency happens when the optimal combination of inputs results in maximum performance at minimum cost which means, when the equilibrium output is delivered at a minimum average cost. This is the case when companies operate at the lowest point of their average total cost curve (i.e. where marginal costs equal average costs). A productive, efficient economy always produces on its production capacity frontier. This means that it is impossible for that economy to produce more of one good or service without reducing the production of another.
It was shown on the above illustration that the production possibility frontier (PPF) for two goods (A and B). If an economy produces 600 units of good A and 450 units of good B, it would not be possible to work at full capacity. More units of both goods could be produced without decreasing the production of the other good. Therefore, we would have productive inefficiency. In case, if the same economy produces 800 units of good A and 600 units of good B, it produces absolutely on the PPF, which result is productively efficient.
Productive efficiency requires all companies to utilize the least costly production factors (e.g. labor, land), the best processes and the most advanced technology available. Furthermore, wastage during the production should be kept to a minimum and possible economies of scale must be realized. If these conditions are met, companies will not be able to produce more goods or services without further input.Note that productive efficiency does not necessarily require allocative efficiency. For example, if the community does not require 800 units of good A and 600 units of good B, the figure above does not describe an allocatively efficient result, although it is productively efficient.
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