Efficiency

• Four types of efficiency:

  • Allocative efficiency
  • Productive efficiency
  • Dynamic efficiency
  • X-Efficiency
• Allocative efficiency occurs when price (AR) is equal to marginal cost. This is where demand is equal to supply; the market clearing price and quantity. At this point, consumer and producer surplus are maximised.

  
• Productive efficiency occurs at the lowest point of the average cost curve, where MC = AC. At this point, all economies of scale are being exploited as firms cannot increase output and lower their costs any further. These lower average costs may translate into lower prices for the consumer, increasing their consumer surplus. For a producer, lower average costs can lead to higher levels of supernormal profit over time and increases in market share if this translates into lower prices than rivals.

  
• Dynamic efficiency occurs when changing technology improves a firm's output potential over time. It can only occur when supernormal profit is being made in the long run. Such profit can then be reinvested back into the company in the form of technology advances, innovative new products and R+D.

  
• X-Efficiency occurs when a firm is producing on the average cost curve at any quantity level. If a firm is X-efficient, they are minimising their unit costs at a given production point, implying that there is no waste in production and all economies of scale are being exploited. A firm may choose to operate above its average cost curve to keep some stakeholders happy, such as employees