BASIC ECONOMIC IDEAS AND
RESOURCE ALLOCATION
EFFICIENT RESOURCE ALLOCATION
EFFICIENT RESOURCE ALLOCATION
• Economic efficiency: where scarce resources
are used in the most efficient way to produce
maximum output.
• Economic efficiency consists of:
1. Productive efficiency
2. Allocative efficiency
Productive efficiency
• Productive efficiency: This occurs when firms
produce at the lowest possible cost. A firm is
productively efficient when it is making the best
use of resources and producing at the lowest cost
possible
• For productive efficiency to exist, goods and
services must be made using the least possible
resources and at the minimum possible cost.
Productive efficiency can be shown
through a firm’s average cost curve as shown
below
• At output q the firm is productive efficient
because it is producing at the least possible
cost
Productive efficiency on a PPC or in an
Economy
• productive efficiency can only exist when an economy is
producing right on the boundary of its production possibility
frontier on point y shown below. The minimum possible
resources are being used to make the products. This is thus a
point of productive efficiency.
• Point x more products could be made with the resources available goods
are not being made using the least possible resources so there is
productive inefficiency.
•
Productive efficiency and Perfect
Competition
Competition can be seen to lead to productive efficiency this is the case as firms
are constrained to produce at the lowest possible cost in a competitive market.
• Firms have the incentive of profit to make their products at the lowest possible
cost: the lower the cost, the greater the possible profit
•
The point of long-run equilibrium for a perfectly competitive firm is given by price p and output q.
At this point, it can be seen that the firm is producing at the lowest point on its average cost
curve. Tis means that there is productive efficiency.
Allocative Efficiency
• This occurs when firms produce the combination of
goods and services that are most wanted by consumers
• Allocative efficiency is all to do with allocating the right
amount of scarce resources to the production of the
right products. This means producing the combination
of products that will yield the greatest possible level of
satisfaction of consumer wants
•
Allocative efficiency
• Allocative efficiency: where price is equal to
marginal
• It exists at P = MC, which means that consumers
pay for the value of the marginal utility they
derive from consuming the good or service. Free
markets are considered to be allocatively efficient
Pareto optimality /Pareto efficiency
• where it is impossible to make someone
better off without making someone else
worse off
• this occurs on the PPF, so there is a trade-off
between producing two different goods and
services.
Dynamic efficiency:
• Dynamic efficiency is a form of productive efficiency
that benefits a firm over time.
• This is when all resources are allocated efficiently over
time, and the rate of
innovation is at the optimum level, which leads to
falling long run average costs. The
market is dynamically efficient if consumer needs and
wants are met as time goes
on. It is related to the rate of innovation, which might
lead to lower costs of
production in the future, or the creation of new
products.
Dynamic Efficiency
• Dynamic efficiency is affected by short run
factors such as demand, interest rates
and past profitability.
• Short run costs might be increased in order to
cause long run costs to fall
• Compiled by M R Chisaka