efficiency

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Types of Efficiency

An Explanation of the Four Types of Efficiency

Allocative Efficiency	Occurs at the level of output where average revenue = marginal cost (AR = MC) At this point, resources are allocated in a way that consumers and producers receive the maximum possible benefit No one can be made better off without making someone else worse off There is no excess demand or supply
Productive Efficiency	Occurs at the level of output where marginal cost = average cost (MC=AC) At this point, average costs are minimised There is no wastage of scarce resources and there is a high level of factor productivity
Dynamic Efficiency	Long-term efficiency is a result of innovation as a firm reinvests its profits It results in improvements to manufacturing methods This lowers both the short-run and long-run average total costs
X-inefficiency	Occurs when a firm lacks the incentive to control production costs. Slack occurs as a consequence The ATC is higher than it should be It often occurs in an industry if there is a lack of competition or in a firm that is not accountable for making a loss (e.g. some government owned companies)

Efficiency & inefficiency in Different Market Structures

Market structures are the characteristics of the market in which a firm or industry operates
- These characteristics typically include
  - The number of buyers
  - The number and size of firms. The market’s concentration ratio
  - The type of product in the market (homogenous or differentiated)
  - The types of barriers to entry and exit
  - The degree of competition
Market structures can be separated into perfect competition and imperfect competition
Imperfect competition includes the following market structures
- Monopolistic
- Oligopoly
- Monopoly

Efficiency and inefficiency in perfect/imperfect competition

Graphs comparing perfect and imperfect competition, showing cost/revenue versus output. Curves include MC, AC, and demand; points marked for equilibrium. — A perfectly competitive market on the top which experiences allocative and productive efficiency. An imperfect market on the bottom in which inefficiencies exist at the profit maximisation level of output

Perfectly competitive market diagram observations

The firm produces at the profit maximisation level of output, where MC=MR (Y)
The firm is productively efficient as MC=AC at this level of output
The firm is allocatively efficient as AR (P)=MC
The firm is unlikely to experience dynamic efficiency as it is unlikely to have supernormal profits to reinvest

Imperfectly competitive market diagram observations

The firm produces at the profit maximisation level of output, where MC=MR (A)
The firm is not productively efficient as AC > MC at this level of output (B-A)
- Productive efficiency would occur at point E, where MC=AC
The firm is not allocatively efficient as AR (P) > MC at this level of output (D-A)
- Allocative efficiency would occur where AR=MC
The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation

Examiner Tips and Tricks

When answering essay questions requiring your knowledge of efficiencies and objectives, always draw a detailed diagram clearly labelling the different objectives and efficiency outputs. Discuss their different price, costs and output levels

Economics_A-level_Edexcel