HOME

TheInfoList



OR:

In
microeconomics Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...
, economic efficiency, depending on the context, is usually one of the following two related concepts: * Allocative or
Pareto efficiency Pareto efficiency or Pareto optimality is a situation where no action or allocation is available that makes one individual better off without making another worse off. The concept is named after Vilfredo Pareto (1848–1923), Italian civil engi ...
: 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 In economics, average cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced (the output Q): AC=\frac. Average cost has strong implication to how firms will choose to price their commodities. Firms’ sale ...
. These definitions are not equivalent: a market or other
economic system An economic system, or economic order, is a system of production, resource allocation and distribution of goods and services within a society or a given geographic area. It includes the combination of the various institutions, agencies, entit ...
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 principles to design and build machines, structures, and other items, including bridges, tunnels, roads, vehicles, and buildings. The discipline of engineering encompasses a broad range of more speciali ...
concept that a system is efficient or
optimal Mathematical optimization (alternatively spelled ''optimisation'') or mathematical programming is the selection of a best element, with regard to some criterion, from some set of available alternatives. It is generally divided into two subfi ...
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 philosophe ...
) given available inputs.


Standards of thought

There are two main standards of thought on economic efficiency, which respectively emphasize the
distortions In signal processing, distortion is the alteration of the original shape (or other characteristic) of a signal. In communications and electronics it means the alteration of the waveform of an information-bearing signal, such as an audio signal ...
created by ''governments'' (and reduced by ''decreasing'' government involvement) and the
distortions In signal processing, distortion is the alteration of the original shape (or other characteristic) of a signal. In communications and electronics it means the alteration of the waveform of an information-bearing signal, such as an audio signal ...
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 libera ...
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 f ...
, 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 val ...
consumers place on it, and equals
marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it ...
. 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
business Business is the practice of making one's living or making money by producing or buying and selling products (such as goods and services). It is also "any activity or enterprise entered into for profit." Having a business name does not separ ...
es, 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 In economics, average cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced (the output Q): AC=\frac. Average cost has strong implication to how firms will choose to price their commodities. Firms’ sale ...
. 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 In economics and political science, fiscal policy is the use of government revenue collection ( taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variabl ...
and
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for federal funds, very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money s ...
) 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 indiv ...
s and imperfections, particularly via internalizing
externalities In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either c ...
. 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 indi ...
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
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 (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 the ...
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, in the Freiburg School of economics.


Microeconomic reform

Microeconomic reform is the implementation of policies that aim to reduce economic distortions via deregulation, 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 compe ...
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 Pareto efficiency or Pareto optimality is a situation where no action or allocation is available that makes one individual better off without making another worse off. The concept is named after Vilfredo Pareto (1848–1923), Italian civil engi ...
* Productive efficiency * Optimisation of a social welfare function *
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 philosophe ...
maximization * X-inefficiency Applications of these principles include: * Efficient-market hypothesis * 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 In welfare economics, the compensation principle refers to a decision rule used to select between pairs of alternative feasible social states. One of these states is the hypothetical point of departure ("the original state"). According to the com ...
* Distribution (economics) *
Economic equilibrium In economics, economic equilibrium is a situation in which economic forces such as supply and demand are balanced and in the absence of external influences the ( equilibrium) values of economic variables will not change. For example, in the st ...
*
Pareto efficiency Pareto efficiency or Pareto optimality is a situation where no action or allocation is available that makes one individual better off without making another worse off. The concept is named after Vilfredo Pareto (1848–1923), Italian civil engi ...
*
Zero-sum game Zero-sum game is a mathematical representation in game theory and economic theory of a situation which involves two sides, where the result is an advantage for one side and an equivalent loss for the other. In other words, player one's gain is e ...


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