3.4.1 Efficiency

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    a) Allocative efficiency
    Allocative efficiency occurs when resources are distributed to the goods and services most desired by the consumer (social welfare is maximised)
    This maximises utility – exists at P = MC – means consumers pay for the value of the marginal utility they derive from consuming the good or service
    Free markets are considered to be allocatively efficient.
    b) Productive efficiency
    This is when firms produce at the lowest point on the average cost curve.
    This is the maximum possible output using the least resources and at the lowest possible cost.
    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.

    c) Dynamic efficiency
    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 o
    Related to the rate of innovation – leads to lower costs of production in the future, or the creation of new products
    Dynamic efficiency is affected by short run factors like demand, interest rates and past probability.
    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.
    Also, some firms will face a trade-off between giving their shareholders dividends and making an investment (Principal-Agent problem)
    d) X-inefficiency
    A firm is x-inefficient when it is producing within the AC boundary. Costs are higher than they would be with competition in the market. The point ‘X’ on the diagram shows x-inefficiency

    Could be due to:
    • Organisational slack • A waste in the production process • Poor management • Simply laziness
    Monopolies tend to be x-inefficient, since they have little incentive to lower their average costs because of the lack of competition they face.

     

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