We are only concerned with the
first section of this chapter on efficiency. Consumer surplus and producer
surplus, covered in subsequent sections, are important concepts in
economics, but they probably are not going to come up in the MBA program.
Efficiency is another term
that we use in everyday language that takes on special meanings in
economics. Economist are concerned with both productive
efficiency and allocative
efficiency. If we want to do the best that we can with
given resources then an economy must achieve both productive efficiency
and allocative proficiency.
termed economic efficiency in Chapter 10, occurs when the cost of
producing a given output is as low as possible. Productive efficiency
encompasses technological efficiency. If we produce the
maximum output given the present set of inputs we have achieved
technological efficiency. This is the type of efficiency that
engineers are most often interested in. Productive efficiency, however,
also requires that we are using a least-cost combination of inputs in
order to produce the existing output.
For example, a given amount of
grain may be produced with a lot of labor and a small amount of capital,
or it may be produced with a lot of capital and a small amount of labor.
As long as we are producing the maximum amount of output given either set
of inputs, then both processes would be technologically efficient.
However, given the relative prices of labor and capital, only one of the
processes may exhibit productive efficiency. In high labor cost regions
like the U.S., it is likely that the capital intensive process would be
productively efficient. It is possible, however, that
technologies that are inefficient in one country may be productively
efficient in another country. Low labor cost regions like the third world
may find the labor intensive process more productively efficient.
We have allocative
efficiency when we produce the "right" basket of goods.
The "right" combination of goods is the market basket that
maximizes society's welfare. Like in "Goldilocks and the Three
Bears" we are searching for the level of output for each and every
good that is "just right." This is the concept of
efficiency that is emphasized in this chapter. Remember, in a
full-employment economy more of one good must mean less of another.
Therefore, if we are producing the wrong amount of one good, it must
create a distortion in the production of at least one other good.
It is possible to have
productive efficiency without also achieving allocative efficiency.
A firm may be producing its current level of output with the best
technology and a least-cost combination of inputs; i.e., it has achieved
both technological efficiency and productive efficiency. This doesn't
mean, however, that the firm is maximizing profits. It may be producing a
level of output that either to small or to large relative to what will be
optimally demanded in the market.
Allocative efficiency can be
defined in terms of marginal benefits and marginal cost. Marginal
benefit may be thought of as the additional or
incremental benefit we derive from having an additional unit of a good. It
is not the total benefit we receive from consumption of the good, only the
benefit attached to the marginally consumed unit. Since the days of Jeremy
his auto-icon) , economists have typically assumed that marginal
benefit declines as we consume more of an item. The next unit of a good
provides less satisfaction than the previous unit of the good.
cost is the additional or incremental cost attached to the
production of an additional unit of the good. It is not the total cost of
producing the good, only the costs attached to the marginally produced
unit. Economists generally assume that marginal cost increases as we
produce more of a good. At some point it costs more to produce the next
unit than it cost to produce the previous unit.
The important point is that we
can judge whether or not we are at the level of output that maximizes
welfare by observing what is happening at the margin. When marginal
benefit exceeds marginal cost (MB>MC), the excess of
marginal benefit over marginal cost represents a net benefit for society.
We could be better off if we produced more of this good. This means we are
not producing an optimal amount of this good. There is too
little of the good produced and there is inefficient underproduction
of the good.
When marginal cost exceeds
marginal benefit (MC>MB), then it costs us more to
produce the last unit than the benefits we derive from that last unit.
This means we could be better off if we reduced production. Too much of he
good is produced and there is inefficient overproduction
of the good.
MB > MC
More production of the good would
MB = MC
MB < MC
production of the good would decrease welfare.