Type: Informative Essays
Sample donated: Gregory Ford
Last updated: April 22, 2019
Economic efficiency refers to the allocation of resources to maximize consumer satisfaction at maximum opportunity cost. Efficiency can be classed into two sorts: allocative efficiency and productive efficiency of which the latter is concerned with production taking place at minimum average cost.
Productive efficiency theoretically exists absolutely in a perfectly competitive market. This is the market structure where forces of demand and supply determine price so firms are price takers and competitive pressures make these short-run profit maximizing firms produce at lowest average cost of production.However in reality, a market structure of perfect competition does not exist because the model of perfect competition is based on the assumptions that factors of production are perfectly mobile, there is perfect information, there are no barriers to entry and exit and that externalities are non-exist. However in a real situation these aspects are not possible and hence firms cannot be perfectly competitive but will only become as near as possible the like of the model. Hence in practice firms cannot absolutely be productivity efficient just as the theory of perfect competition shows.
In fact, it is the imperfect market structures such as monopolistic competition, oligopoly and monopoly that find ground in reality. Monopolistic competition is a market structures with many firms producing differentiated products and having enough power to be price- makers. Oligopolists are few large firms that has the greatest market share, produce differentiated products, are price-makers and in this market structure barriers to entry exist.
Monopoly is a single firm that produces all the output in the market, set price and erects barriers to entry or there are already natural barriers to entry present.Allocative efficiency is concerned with the ideal quantity of goods produced that maximizes consumer satisfaction. It is a more abstract concept as it involves personal views on efficient levels of output.
For examples, firms in free market system are likely to produce goods and services for the people who are able to pay for the goods. And so the poorer groups are unable to attain products and increase their utility. Therefore the use of resources are said to be allocatively inefficient as firms are not targeting at maximizing consumers’ satisfaction with the resources’ use.Also private firms will not pay heed to the negative externalities such as pollution that it creates. If the production level that reduces the producers profits, the production level will not take place. Hence the use of resources is allocatively inefficient.
When the price consumers pay for a product is equal to the marginal cost of producing it, the use of resources is said to be allocatively efficient. This is theoretically an ideal level of output but the theory assumes that marginal costs in all industries are identical.But in practice this is not the case nor is it entirely possible.
Different industries and even firms will have different marginal costs due to differences in variable or fixed costs and hence in reality prices cannot be equalized with marginal cost and hence allocative efficiency is not achieved. Also there are factors with ordinal measures that are significant for resource allocation. For example, satisfaction itself. Consumer satisfaction cannot be given absolute cardinal values.Some products such as the differentiated products produced by imperfectly competitive firms can give ‘upon consumers’ tastes and preferences. Therefore consumers value variety and the price that they pay, which exceeds the marginal cost of producing it, could well reflect this value (even if the value is not a fixed number). In this sense, monopolists, oligopolists, monopolistic firms can achieve allocative efficiency.
Monopolists, oligopolists and monopolistic firms are large firms who hold the capability of investing into research and development.Consumers benefit from this as product with improved design and features can be produced. Research and development also means that production methods can be improved and firms can reduce the extent of pollution and wastage. Hence firms can become allocatively efficient. It is also that the large firms are able to achieve economies of scale and will be able to move down their long-run average cost curve and hence reach near the minimum efficient scale i. e. the level of output where average costs are the lowest. Hence large firms could possibly be productively efficient.
However, sometimes firms have very large economies of scale but the size of the firm itself do not increase so much and hence firms are unable to reap all economies of scale. Firms’ long-run average cost structures also differ. Instead of the conventional U-shaped cost curve firms may have L-shaped cost curve or continuously downward-sloping curve all of which determines whether a firm can be productively efficient or not. Advertising is an important phenomenon in the modern economy. Firms in imperfect markets advertise heavily for their product.
They use either informative or persuasive forms of advertising. If people consume more product because they gained potential benefits from the information of advertising then allocative efficiency has been increased. However persuasion may distort consumer’s choice being taken in a rational way. As a result consumers may be coerced to consume goods and services that does not qualitatively improve lifestyles or bring benefits to the society. For example, the soft-drink brand coca-cola is estimated to be the world’s largest producer and the product is believed to be most consumed globally.The success was due to the company’s successful advertising and introduction of the product even to the remote areas via vending machines.
Consumer’s satisfaction worldwide is increased by producing the drink and hence it can be argued that all resources are being allocated to this industry efficiently. But existence of basic needs unfulfilled around the globe and the potential health risks by consuming the soft drink as well as the increased pollution due to disposal of the number of cans and bottles would indicate that resources are inefficiently being allocated to this industry.Hence there exists allocative inefficiency. Scarce resources have alternative uses. Almost every use involves a number of complex costs and benefits to the society.
The proper use of the resources is difficult to evaluate due to the existence of conflicts, different interests and ethical issues. Economic efficiency itself as described in text books carry assumptions that may not be entirely possible but this largely depends on how the people concerned view efficiency.