Types of efficiency

Efficiency is a central concept in economics and is used to analyse and evaluate how resources are used.

The two most basic uses of the term relate to how scarce resources are best used, and how goods and services are allocated.

Efficiency can either be considered at one point in time (called static efficiency) or over time (called dynamic efficiency).

Productive efficiency

Productive efficiency concerns the relationship between the input of scarce resources and the output of goods and services.

This can be aplied in two different contexts.

Firstly, we can consider the efficiency of a single firm, which concerns the average cost of production. A productively efficient output is one where average cost is at its lowest. (Read more on this here).

Secondly, we can consider productive efficiency for a whole economy. In this context, a productively efficient level of output is where all an economy's scarce resources are being used. This can be shown through production possibility curves - productive efficiency means producing on the edge of the curve.

Allocative efficiency

Allocative efficiency relates to whether consumers pay a price for a unit of a good or service that equates to the cost of the good or service in terms of the scarce resources used.

For example, it is allocatively efficient if a consumer pays £1 for a carton of orange juice which costs £1 to produce. This seems strange until we look at how we define production costs. Included in the costs of production is a reward to all the factors of production (costs include raw material costs, rents, wages, interest, and a normal profit to the entrepeneur).

So, if the carton of orange juice that the consumer purchased for £1 inclurs costs of:

Costs
Raw materials	0.25
Wages	0.35
Interest	0.10
Rents	0.10
Normal profit	0.20
Total cost of 1 carton	£1.00

In this case, there is allocative efficiency - the price the consumer pays covers the costs of production.

In certain markets, goods are not allocated efficiently, including markets dominated by one firm or a few firms.