Efficient Resource Allocation

Topic 1: Basic Economic Ideas
and Resource Allocation
a) Efficient resource
allocation
Economic
efficiency
Allocative Productive
efficiency efficiency
Economic Efficiency
 Economic efficiency occurs when scare resources are
used in the best possible way.
 It represents the best possible solution to the basic
economic problem of scarcity & choice
Productive efficiency
 Occurs when resources are used to give the maximum
possible output at the lowest possible cost
 It is achieved when a firm produces its output at the lowest
AC or at a point on PPC. Production on the lowest point on
the lowest AC is called point is called technical efficiency
 Productive efficiency helps keep the price down
 Benefit : Maximise consumers’ welfare

 Disadvantages :
 Can be wasteful if the goods and services consumers want
are not produced
 Unequal benefits to consumers - some consumers benefit
with the allocation of more resources to them, so this
means that other consumers lose out. This is because all
resources are used to their maximum productive potential,
so there is no spare capacity
• No spare capacity happens when firms produce at the lowest
point on the average cost curve (Point X).
• Since the MC curve cuts the AC curve at the lowest point, MC =
AC is a point of productive efficiency. All points on the PPF curve
are productively efficient.
X - The point of lowest LRAC : the

most productively efficient level of
output
Allocative efficiency
 Occurs when resources are allocated to the best interests of
society, where there is maximum social welfare and maximum
utility
 The goods and services consumers want might be produced
where there is allocative efficiency, but they also need to be
affordable
 Allocative efficiency exists at P = MC & firms are producing the
most wanted products ,which means that consumers pay for the
value of the marginal utility# they derive from consuming the
good or service.
# Note : Utility
 Utility : A measure of the satisfaction that we get from purchasing
and consuming a good or service
 Total utility: The total satisfaction from a given level of
consumption
 Marginal utility : The change in total satisfaction from consuming
an extra unit of a good or service
 It is not possible to illustrate allocative efficiency on PPF as it
is defined by consumer preferences which could be on any
point at the PPF
 Competitive / free markets are forced to produce ‘the most
wanted products’ hence they achieve allocative efficiency
 Productive efficiency + Allocative efficiency = Optimum
resources allocation
Pareto optimality
 Pareto efficiency (also: optimality) occurs when resources are allocated
optimally, so every consumers’ benefits and waste is minimised.
 However, in a competitive market, it is impossible to allocate resources
to benefit one person, without making another person worse off
 This involves movement along the PPF, so there is a trade – off
(opportunity cost) between producing 2 different goods & services.
• A production possibility frontier (PPF)
shows the maximum possible output
combinations of two goods or
services an economy can achieve
when all resources are fully and
efficiently employed.
• Points A & B are Pareto Efficient as a C
certain amount of good has to be

given up in order to produce more of
another good
• Point C is Pareto Inefficient as it is
impossible to increase either good
without leading to the decline in the
output of another
Dynamic efficiency:
 Dynamic efficiency involves improving allocative and productive
efficiency over time. This can mean developing new or better
products and finding better ways of producing goods and services
 This is when all resources are allocated efficiently over time, and
the rate of innovation is at the optimum level, which leads to falling
long run average costs
 The market is dynamically efficient if consumer needs and wants are
met as time goes on
 It is related to the rate of innovation, which might lead to lower
costs of production in the future, or the creation of new products.
LRAC shifts
downwards as the firm
invests more in capital
intensive production
lowering costs in the
LR
 Dynamic efficiency is affected by short run factors such
as:-
 demand
 interest rates
 past profitability
 Short run costs might be increased in order to cause long

run costs to fall
 Dynamic efficiency can be evaluated by considering the

long time lag between making an investment and having
falling average costs and by considering how factors
change in the long run. Moreover, some firms will face a
trade-off between giving their shareholders dividends
and making an investment.

Efficient Resource Allocation

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Topic 1: Basic Economic Ideas

and Resource Allocation

 Benefit : Maximise consumers’ welfare

X - The point of lowest LRAC : the

certain amount of good has to be

 Short run costs might be increased in order to cause long

 Dynamic efficiency can be evaluated by considering the

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