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Productive and Allocative Efficiency



Productive and allocative efficiency, technical efficiency

Equations are omitted for technical reasons - download the original pdf

Productive efficiency is defined to be the production of goods and services at minimum cost. This means that it is not possible to produce more of any one good without producing less of another. Allocative efficiency, which is also called Pareto efficiency is defined to be a situation where it is not possible to improve one consumer's welfare without making another consumer worse off. A distribution that is allocatively efficient can be "unfair" in the sense of unequitable. Allocative efficiency is not necessarily a situation in which everyone obtains the same income or an equal distribution of goods. There is also the concept of technical efficiency. Production is technically efficient when a given quantity of output is produced using the minimum quantity of factor inputs. For example, if a firm could employ fewer workers to produce the same amount of goods, then it is not technically efficient. However, a firm that is technically efficient may not be productively efficient, since there may be some other bundle of the factors of production that might produce the same quantity of goods at a lower cost. For example, a technically efficient firm might employ 1m of capital and 10 workers to produce a given quantity, but by using 2m of capital and 2 workers it might produce the same quantity at lower cost. Likewise, all allocatively efficient outputs must be productively efficient, but not vice-versa. If a country is not productively efficient then it is possible to increase one consumer's welfare without making another worse off. That is, by becoming productively efficient more goods are produced for no extra factor input. These extra goods can be distributed (allocated), thus making one or more people better off without making anyone else worse off. The relationship between the three kinds of efficiency can be represented by the following (Venn) diagram. [Diagram goes here - download the original pdf to see it.]
Contents of
Productive and Allocative Efficiency

1 Productive and allocative efficiency, technical efficiency
2 Productive efficiency and the allocation of resources, production possibility frontier
3 The relationship of productive to allocative efficiency
4 Indifference curves
5 Equity and Pareto efficiency
6 Allocative efficiency and the justification of capitalism
7 Utility frontier in the context of Pareto (allocative) efficiency
8 Competition and the efficient allocation of resources

Related articles: (1) The Economic Problem, (2) Productive and Allocative Efficiency