Business Efficiency In Depth

• Allocative efficiency


  Occurs where demand equals supply in a market, maximizing the sum of producer and consumer surplus
• Allocative efficiency on a business diagram

  Where price equals marginal cost
• Allocative efficiency for consumers


  • Resources are following consumer demand, consumers get exactly what they want in the quantity they want, low prices maximizing consumer surplus, high choice and high quality of production
• Allocative efficiency for producers

  • Allows them to retain or increase market share, increase profits by bringing more consumers
• Productive efficiency


  Maximization of output at the lowest possible average cost, full exploitation of economies of scale
• Where productive efficiency occurs

  At the lowest point of average cost, where marginal cost equals average cost
• Productive efficiency for consumers

  • Lower average costs may be passed on as lower prices, increasing consumer surplus
• Productive efficiency for producers

  • More production at lower costs, translates to higher profits, allows them to stay ahead of rivals by retaining or increasing market share
• Dynamic efficiency


  Reinvesting supernormal profit into R&D and new technology to lower long run average costs over time
• Condition for dynamic efficiency

  Existence of supernormal profit in the long run
• Dynamic efficiency for consumers

  • Leads to innovative new products, lower prices over time due to new technology and production techniques, increased competition
• Dynamic efficiency for producers

  • Allows for long run profit maximization, staying ahead of rivals, gaining patents/copyrights/licenses, increasing market power
• 1. efficiency


  Production with no waste, production at any point on the average cost curve
• 1. efficiency for consumers


  • Lower costs may be passed on as lower prices, increasing consumer surplus
• 1. efficiency for producers


  • Lower costs mean higher profits, allows them to pass on lower prices to increase or retain market share
• Allocative, productive and x-efficiency are static efficiencies as they occur at a specific production point, while dynamic efficiency takes place over time