11w-41-2a
10s-41-2a
Explain the productive efficiency and allocative efficiency. [12]
13-w-41-7a
15-w-41-2a
19s-41-2a
Sample essay
Part 1: explain economic efficiency (Pareto optimality)
Economic efficiency means that the greatest possible level of infinite wants is being met with
those scarce resources. In this case, Pareto optimality occurs as it is impossible to make someone
better off without making someone else worse off.
Economic efficiency consists of productive efficiency and allocative efficiency.
Part 2: explain allocative efficiency (P = MC)
An economy is said to achieve allocative efficiency when right products are produced with right
quantity, which is also means that this combination of products with scarce resources would lead
to the best satisfaction for consumers. In particular, every good or service is produced up to the
point where the last unit provides a marginal benefit to consumers equal to the marginal cost of
producing it. Thus, the condition required for allocative efficieny is P = MC. When this happens
economic welfare measured in terms of consumer and producer surplus is maximized. The graph
below illustrates allocative efficiency.
The optimum allocation of resources is where QD = QS, producing an output oq at price op. So,
the equilibrium in the market implies P = MC, hence generating maximum possible amounts of
consumer and producer surplus. A situation where either P > MC or P < MC implies inefficient
allocation of resources. Following graph illustrates these cases.
At an output of 100 units, P >MC and it indicates that fewer resources have been allocated than
what are required to achieve perfect allocation. Therefore, an increase in output up to 200 units
would increase both consumer and producer surplus indicated by triangle A and hence would
improve allocative efficiency. On the other hand, P < MC signifies that too many resources have
been allocated for production. In the graph above the production of 300 units, for instance,
suggests over allocation of resources. The shaded triangle B represents welfare loss form the
alternative product.
Part 3: explain productive efficiency (lowest AC for firms & on
the PPC for economy)
Productive efficiency will be achieved when a firm is producing at lowest possible cost.
According to the diagram above, if a firm is producing at Qe, it is producing at the lowest possible
average total cost and minimize the wastage of resources. The firm fully uses the scarce
resources in the most efficient way.
For an economy, productive efficiency can only exist when an economy is producing on the
boundary of its PPC.
According to the diagram above, point X is productive inefficient as more products could be made
with the resources available. However, at point Y, it is not possible to produce any more because
of the scarce resources that are available to the economy. As a consequence, producing at point Y
is productively efficient and all firms in the economy are producing at the lowest possible ATC
curve.
Part 4: refer efficiency in perfect competition
Competition can improve both allocative and productive efficiency. Economic efficiency will be
achieved in a perfect competition market structure.
In perfect competitive market, there are many buyers and many firms producing homogeneous
goods, consumers have perfect knowledge of the product and there are zero entry barriers in the
industry. Given these assumptions, producers are price-takers. If a firm is producing at profit-
maximizing output (MR = MC), both allocative and productive efficiency are achieved as shown in
the diagram below.
The diagram above shows that the firm is producing where MR = MC. At this point, P = MC and
average cost is minimized. Thus, we have both allocative and productive efficiency.
Part 5: conclusion: the importance of efficiency
As resources are limited while people have unlimited wants, we aim for economic efficiency in
order to maximize the use of the scarce resources. In other words, we don’t want resources to be
wasted. If there is productive or allocative inefficiency, we could produce or reallocate resources
in a more efficient way.