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In microeconomics, economic efficiency, depending on the context, is usually one of the following two related concepts: * Allocative or Pareto efficiency: any changes made to assist one person would harm another. * Productive efficiency: no additional output of one good can be obtained without decreasing the output of another good, and production proceeds at the lowest possible average total cost. 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 Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including bridges, tunnels, roads, vehicles, and buildings. The discipline of engineering encompasses a broad rang ...
concept that a system is efficient or optimal when it maximizes desired outputs (such as
utility As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosoph ...
) 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 Economic liberalism is a political and economic ideology that supports a market economy based on individualism and private property in the means of production. Adam Smith is considered one of the primary initial writers on economic liberalis ...
or
neoliberalism Neoliberalism (also neo-liberalism) is a term used to signify the late 20th century political reappearance of 19th-century ideas associated with free-market capitalism after it fell into decline following the Second World War. A prominent ...
, 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 A marginal value is #a value that holds true given particular constraints, #the ''change'' in a value associated with a specific change in some independent variable, whether it be of that variable or of a dependent variable, or # hen underlying valu ...
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 In economics, scarcity "refers to the basic fact of life that there exists only a finite amount of human and nonhuman resources which the best technical knowledge is capable of using to produce only limited maximum amounts of each economic good ...
, 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. Productive efficiency 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.


Mainstream views

The mainstream view is that market economies are generally believed to be closer to efficient than other known alternativesEconomics, fourth edition, Alain Anderton, p281 and that government involvement is necessary at the macroeconomic level (via fiscal policy and
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often ...
) to counteract the economic cycle – following
Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output ...
. At the microeconomic level there is debate about how to achieve efficiency, with some advocating
laissez-faire ''Laissez-faire'' ( ; from french: laissez faire , ) is an economic system in which transactions between private groups of people are free from any form of economic interventionism (such as subsidies) deriving from special interest groups. ...
, to remove government distortions, while others advocate regulation, to reduce
market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where ...
s and imperfections, particularly via internalizing externalities. 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 imperfection In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where indiv ...
s, 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.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.


Schools of thought

Advocates of limited government, in the form
laissez-faire ''Laissez-faire'' ( ; from french: laissez faire , ) is an economic system in which transactions between private groups of people are free from any form of economic interventionism (such as subsidies) deriving from special interest groups. ...
(little or no government role in the economy) follow from the 19th century philosophical tradition
classical liberalism Classical liberalism is a political tradition and a branch of liberalism that advocates free market and laissez-faire economics; civil liberties under the rule of law with especial emphasis on individual autonomy, limited government, e ...
. They are particularly associated with the mainstream economic schools of classical economics (through the 1870s) and
neoclassical economics Neoclassical economics is an approach to economics in which the production, consumption and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a good ...
(from the 1870s onwards), and with the
heterodox In religion, heterodoxy (from Ancient Greek: , "other, another, different" + , "popular belief") means "any opinions or doctrines at variance with an official or orthodox position". Under this definition, heterodoxy is similar to unorthodoxy, w ...
Austrian school The Austrian School is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result exclusively from the motivations and actions of individuals. Austrian scho ...
. Advocates of an expanded government role follow instead in alternative streams of progressivism; in the
Anglosphere The Anglosphere is a group of English-speaking nations that share historical and cultural ties with England, and which today maintain close political, diplomatic and military co-operation. While the nations included in different sources vary, ...
(English-speaking countries, notably the United States, United Kingdom, Canada, Australia and New Zealand) this is associated with
institutional economics Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behavior. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on t ...
and, at the macroeconomic level, with
Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output ...
. In Germany the guiding philosophy is
Ordoliberalism Ordoliberalism is the German variant of economic liberalism that emphasizes the need for government to ensure that the free market produces results close to its theoretical potential but does not advocate for a welfare state. Ordoliberal ide ...
, in the Freiburg School of economics.


Microeconomic reform

Microeconomic reform is the implementation of policies that aim to reduce economic distortions via
deregulation Deregulation is the process of removing or reducing state regulations, typically in the economic sphere. It is the repeal of governmental regulation of the economy. It became common in advanced industrial economies in the 1970s and 1980s, as a r ...
, and move toward economic efficiency. However, there is no clear theoretical basis for the belief that removing a
market distortion In neoclassical economics, a market distortion is any event in which a market reaches a market clearing price for an item that is substantially different from the price that a market would achieve while operating under conditions of perfect competit ...
will always increase economic efficiency. 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.


Criteria

Economic efficiency can be characterized in many ways: * Allocative efficiency * Distributive efficiency *
Dynamic efficiency In economics, dynamic efficiency is a situation where it is impossible to make one generation better off without making any other generation worse off. It is closely related to the notion of "golden rule of saving". Are modern economies dynamical ...
* Informational efficiency is the most-discussed type of financial market efficiency. * Kaldor–Hicks efficiency * Operational efficiency * Pareto efficiency * Productive efficiency * Optimisation of a
social welfare function In welfare economics, a social welfare function is a function that ranks social states (alternative complete descriptions of the society) as less desirable, more desirable, or indifferent for every possible pair of social states. Inputs of the ...
*
Utility As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosoph ...
maximization * X-inefficiency Applications of these principles include: *
Efficient-market hypothesis The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted b ...
* Microeconomic reform * Production theory basics * Welfare economics


See also

*
Business efficiency The efficiency ratio indicates the expenses as a percentage of revenue (''expenses'' / ''revenue''), with a few variations – it is essentially how much a corporation or individual spends to make a dollar; entities are supposed to attempt minimizi ...
* Compensation principle *
Distribution (economics) In economics, distribution is the way total output, income, or wealth is distributed among individuals or among the factors of production (such as labour, land, and capital). In general theory and in for example the U.S. National Income and P ...
* Economic equilibrium * Pareto efficiency * Zero-sum game


References


Further reading

* Patnaik, Prabhat (1997). "On the Concept of Efficiency". ''Economic and Political Weekly''. October 25, 1997.


External links


"Efficiency"
article by Paul Heyne {{Authority control Microeconomics Economic reforms