Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes
Efficiency is concerned with the optimal production and distribution of scarce resources.
Different types of efficiency
- Productive – producing for the lowest cost.
- Allocative – distributing resources according to consumer preference P=MC
- Dynamic – Efficiency over time.
- X – inefficiency – No incentive to cut costs
Occurs on the lowest point of the average cost curve. This is the point where mc cuts across the ac curve. Firms are their most productive when their average costs are at the lowest point.
Here, competitive firms will be generating normal profit where AR = AC. The profit being made is just enough to keep their resources employed.
Occurs where P = MC. This is where MC = AR. Allocative efficiency can be thought of as the right quantity being produced at the right price. This occurs when goods and services are distributed according to consumer preferences. An economy could be productively efficient but produce goods people don’t need, making it allocatively inefficient.
A more precise definition of allocative efficiency is the output level where the Price equals the Marginal Cost (MC) of production. This is because the price that consumers are willing to pay is equivalent to the marginal utility that they get.
At Point A, firms are Productively Efficient.
At Point B, firms are Allocatively Efficient.
In the Long Run, firms in a monopolistically competitive market will also make normal profit at the point where P = MC.
This usually occurs in imperfectly competitive markets and when firms do not have incentives to cut costs. For example, a monopoly which makes supernormal profits may have little incentive to get rid of surplus labour.
Monopolies have a lack of competition and also dominate the market. Therefore, they can afford to be inefficient by issuing high prices as customers will still consume their products / services. Monopolies also have high barriers to entry, stopping entrance into the market and causing x-inefficiency
Dynamic efficiency (Innovation)
This refers to efficiency over time. For example, a Ford factory in 2010 may be inefficient for that specific time period. However, if it gained relative advantage by 2017, it would now be classed as ‘efficient’. Dynamic efficiency involves the introduction of new technology and working practices to reduce costs over time.
Innovation = more efficient = lower average costs
Amazon do not provide dividends to shareholders, instead they reinvest profits into the business
Efficiency / Inefficiency in different market structures
Firms in a perfectly competitive market are productively efficient as they produce at MC = AC
Firms are also allocatively efficient since they produce at P = MC, this also makes the statically efficient
Since firms in perfect competition do not make as much profit, they have less money available for R & D and innovation, therefore are not dynamic efficient
Firms in monopolistically competition can only make normal profit in the long run, however they are able to profit maximise. Therefore, firms will not allocatively or productively efficient.
Products produced in a dynamically efficient market are differentiated, hence firms are likely to be dynamically efficient
Firms are dynamically efficient as they make supernormal profits in the long-run, hence they have more money available for investment into R&D and innovation
Firms in an oligopoly are not productively efficient or allocatively efficient – this makes them statically efficient
Since monopolies can profit maximise and generate supernormal profit, they are dynamically efficient
Quick Fire Questions – Knowledge Check
- Identify the four main types of efficiencies (4 marks)
- Using a diagram, explain what Productive Efficiency is (4 marks)
- Using a diagram, explain what Allocative Efficiency is (4 marks)
- Identify the point at which Allocative Efficiency occurs (2 marks)
- Identify whether Productive Efficiency and Allocative Efficiency can ever occur at the same time (2 marks)
- Explain what x-inefficiency is (4 marks)
- Using an example, explain how X-inefficiency may occur (4 marks)
- Explain what Dynamic Efficiency is (4 marks)
- Using an example, explain how Dynamic Efficiency may occur (4 marks)
- Explain the efficiencies / inefficiencies which occur in the different market structures (10 marks)
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