![Productive efficiency](https://upload.wikimedia.org/wikipedia/commons/9/9c/Productive_efficiency.svg)
In
microeconomic theory
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 ...
, productive efficiency (or production efficiency) is a situation in which the
economy
An economy is an area of the production, distribution and trade, as well as consumption of goods and services. In general, it is defined as a social domain that emphasize the practices, discourses, and material expressions associated with the ...
or an
economic system
An economic system, or economic order, is a system of Production (economics), production, resource allocation and Distribution (economics), distribution of goods and services within a society or a given geographic area. It includes the combinati ...
(e.g., bank, hospital, industry, country) operating within the constraints of current
industrial technology
Industrial technology is the use of engineering and manufacturing technology to make production faster, simpler, and more efficient. The industrial technology field employs creative and technically proficient individuals who can help a company ac ...
cannot increase
production
Production may refer to:
Economics and business
* Production (economics)
* Production, the act of manufacturing goods
* Production, in the outline of industrial organization, the act of making products (goods and services)
* Production as a stati ...
of one
good
In most contexts, the concept of good denotes the conduct that should be preferred when posed with a choice between possible actions. Good is generally considered to be the opposite of evil and is of interest in the study of ethics, morality, ph ...
without sacrificing production of another good. In simple terms, the concept is illustrated on a
production possibility frontier
Production may refer to:
Economics and business
* Production (economics)
* Production, the act of manufacturing goods
* Production, in the outline of industrial organization, the act of making products (goods and services)
* Production as a stati ...
(PPF), where all points on the curve are points of productive efficiency.
An
equilibrium may be productively efficient without being
allocatively efficient — i.e. it may result in a distribution of goods where
social welfare
Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...
is not maximized (bearing in mind that social welfare is a nebulous
objective function
In mathematical optimization and decision theory, a loss function or cost function (sometimes also called an error function) is a function that maps an event or values of one or more variables onto a real number intuitively representing some "cos ...
subject to political controversy).
Productive efficiency is an aspect of
economic efficiency
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 addit ...
that focuses on how to maximize output of a chosen product portfolio, without concern for whether your product portfolio is making goods in the right proportion; in misguided application, it will aid in manufacturing the wrong basket of outputs faster and cheaper than ever before.
Productive efficiency of an industry requires that all firms operate using best-practice technological and
managerial
Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managing resources of the business.
Management includes the activities ...
processes and that there is no further reallocation that bring more output with the same inputs and the same production technology. By improving these processes, an economy or business can extend its production possibility frontier outward, so that efficient production yields more output than previously.
Productive inefficiency, with the economy operating below its production possibilities frontier, can occur because the productive inputs
physical capital
Physical capital represents in economics one of the three primary factors of production. Physical capital is the apparatus used to produce a good and services. Physical capital represents the tangible man-made goods that help and support the produc ...
and
labor
Labour or labor may refer to:
* Childbirth, the delivery of a baby
* Labour (human activity), or work
** Manual labour, physical work
** Wage labour, a socioeconomic relationship between a worker and an employer
** Organized labour and the la ...
are underutilized—that is, some capital or labor is left sitting idle—or because these inputs are allocated in inappropriate combinations to the different industries that use them.
In
long-run equilibrium In economics, the long-run is a theoretical concept in which all markets are in equilibrium, and all prices and quantities have fully adjusted and are in equilibrium. The long-run contrasts with the short-run, in which there are some constraints an ...
for perfectly competitive markets, productive efficiency occurs at
the base of the
average total cost curve — i.e. where
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 r ...
equals average total cost — for each good.
Due to the nature and culture of
monopolistic
A monopoly (from Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a spec ...
companies, they may not be productively efficient because of
X-inefficiency X-inefficiency is the divergence of a firm’s observed behavior in practice, influenced by a lack of competitive pressure, from efficient behavior assumed or implied by economic theory. The concept of X-inefficiency was introduced by Harvey Leib ...
, whereby companies operating in a monopoly have less of an incentive to maximize output due to lack of competition. However, due to
economies of scale
In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time. A decrease in cost per unit of output enables ...
it can be possible for the profit-maximizing level of output of monopolistic companies to occur with a lower price to the consumer than perfectly competitive companies.
Theoretical measures
Many theoretical measures of production efficiency have been proposed in the literature as well as many approaches to estimate them.
The most popular measures of efficiency include Farrell measure (also known as Debreu–Farrell measure, since Debreu (1951) has similar ideas). This measure is also the reciprocal of the Shephard's distance function. These can be defined with either the input orientation (fix outputs and measure maximal possible reduction in inputs) or the output orientation (fix inputs and measure maximal possible expansion in outputs).
A generalisation of these is the so-called directional distance function, where one can select any direction (or orientation) for measuring the production efficiency.
The most popular for estimating production efficiency are
data envelopment analysis
Data envelopment analysis (DEA) is a nonparametric method in operations research and economics for the estimation of production frontiers.Charnes et al (1978) DEA has been applied in a large range of fields including international banking, econom ...
and
stochastic frontier analysis.
See the recent book by Sickles and Zelenyuk (2019) for comprehensive coverage of the theory and related estimation and many references therein.
[ Sickles, R., & Zelenyuk, V. (2019). Measurement of Productivity and Efficiency: Theory and Practice. Cambridge: Cambridge University Press. doi:10.1017/9781139565981]
References
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Production economics