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Economic efficiency

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  • In economics, money is used as a unit of account to measure value. The value of a good or service to a consumer is given by the price the buyer is willing to pay. Willingness to pay (WTP) is the maximum price a consumer is prepared pay to obtain a product rather than forego consumption and shown by the demand curve. WTP is used as a measure of a consumer’s marginal private benefit (MPB) ie D=WTP In theory, free and perfectly competitive markets produce the goods and services consumers most want in the right quantities and at the lowest possible cost. This is why markets are said to be so powerful and ‘work’.
  • Productive efficiency can be defined as: Using the least amount of resources to produce a given product or Output is being produced at the lowest possible unit cost
  • Internal Economies of Scale are lower long run unit costs from an increase in the amount of labour & capital used in production A firm can be technically efficient - ie at the lowest point of its SAC curve - and still fails to exploit all potential economies of scale. In the diagram, economies of scale mean the long run average cost curve (LRAC) curve slopes downwards until the Minimum Efficient Scale of output is reached and all potential economies of scale are exhausted. Productive efficiency implies firms are using the least costly labour capital & land inputs in both the short and long run by utilising the best available technology & best production processes. They are exploiting all potential economies of scale and minimise the wastage of resources in their production processes.

Transcript

  • 1. Economic Efficiency Section 10.4 Production and Efficiency AS Economics
  • 2. Economic Efficiency
    • Efficiency relates to how well a market or economy allocates scarce resources to satisfy unlimited wants.
    • Efficiency occurs when society is using its scare resources to produce the highest possible amount of goods and services that consumers most want to buy (produces on PPF)
    • Efficiencies fall into two types:
  • 3. Static & Dynamic Efficiency
    • 1. Static Efficiency
      • How efficient a firm/economy is at a certain point in time
      • All the efficiencies we’re looking at are static efficiencies.
    • 2. Dynamic Efficiency
      • This looks at improvements in technical, allocative and productive efficiency over time.
      • Improvements in dynamic efficiency occur due to improvements in competition, technology, innovation and invention.
  • 4. Allocative Efficiency
    • Allocative efficiency occurs when the value that consumers place on a good or service equals the cost of the resources used up in production
    • The technical condition required for allocative efficiency is that price = marginal cost (same as D=S in a perfect market)
    • When this happens, total economic welfare is maximized
    • When the goods produced are actually what the consumer wants (not like USSR and shoes).
    • In other words it occurs when no-one could be better off without making someone else worse off (Pareto).
  • 5. Showing allocative efficiency Costs Revenues Output (Q) Demand Supply P1 Q1 Consumer Surplus (CS) Producer Surplus (PS) Consumer Surplus (CS) Producer Surplus (CS)
  • 6. A loss of allocative efficiency if output is too low and price too high Costs Revenues Output (Q) Demand Supply P1 Q1 Consumer Surplus (CS) Producer Surplus (PS) P2 Q2 Price level P2 and output Q2 leads to a higher level of producer surplus but a lower level of consumer surplus
  • 7. Deadweight loss of welfare Costs Revenues Output (Q) Demand Supply P1 Q1 Consumer Surplus (CS) Producer Surplus (PS) P2 Q2 Loss of economic welfare from output being below the optimal level
  • 8. A loss of allocative efficiency if output is too high and price too low Costs Revenues Output (Q) Demand Supply P1 Q1 Consumer Surplus (CS) Producer Surplus (PS) P2 Q3
  • 9. Productive efficiency
    • Productive efficiency refers to a firm's costs of production and can be applied both to the short and long run production time-span
    • It is achieved when the output is produced at minimum average total cost (ATC) i.e. when a firm is exploiting most of the available economies of scale (MES)
    • Productive efficiency exists when producers minimize the wastage of resources in their production processes.
    • Any point lying on the production possibility boundary is productively efficient
  • 10. The long run average cost curve Costs Output (Q) SRAC1 SRAC2 SRAC3 Q1 Q2 Q3 AC1 AC2 AC3 LRAC Productive efficiency in the long run is achieved when output is produced at the bottom of the long run average cost curve
  • 11. Productive and allocative efficiency
    • There is little point in producing items at lowest cost if they are not the products most valued by consumers.
    • Productive efficiency is a necessary but insufficient condition for an optimal allocation of resources .
    • Allocative efficiency is also required.
  • 12. X-inefficiency
    • Tendency for costs to rise in a firm with few or no competitors to incentivise cost-cutting.
    • X-inefficiency tends to occur in monopoly situations.
    • Although X-inefficiency can also be caused by a firm simply being too inefficient.
  • 13. Pareto efficiency (optimality)
    • Pareto efficiency occurs when resources cannot be reallocated to make one consumer better off without making someone worse off.
    • Pareto efficiency can be illustrated using a production possibility frontier (PPF)
    • Any point within the PPF is inefficient. Using idle resources to increase output means some consumers gain while no consumers lose.