microeconomics Microeconomics is a branch of economics that studies the behavior of individuals and Theory of the firm, firms in making decisions regarding the allocation of scarcity, scarce resources and the interactions among these individuals and firms. M ...

, economic efficiency, depending on the context, is usually one of the following two related concepts: * Allocative or

Pareto efficiency In welfare economics, a Pareto improvement formalizes the idea of an outcome being "better in every possible way". A change is called a Pareto improvement if it leaves at least one person in society better off without leaving anyone else worse ...

: any changes made to assist one person would harm another. * Productive efficiency: no additional output of one good can be obtained without decreasing the output of another good, and production proceeds at the lowest possible average total cost. These definitions are not equivalent: a market or other

economic system An economic system, or economic order, is a system of production, resource allocation and distribution of goods and services within an economy. It includes the combination of the various institutions, agencies, entities, decision-making proces ...

may be allocatively but not productively efficient, or productively but not allocatively efficient. There are also other definitions and measures. All characterizations of economic efficiency are encompassed by the more general

engineering Engineering is the practice of using natural science, mathematics, and the engineering design process to Problem solving#Engineering, solve problems within technology, increase efficiency and productivity, and improve Systems engineering, s ...

concept that a system is efficient or optimal when it maximizes desired outputs (such as

utility In economics, utility is a measure of a certain person's satisfaction from a certain state of the world. Over time, the term has been used with at least two meanings. * In a normative context, utility refers to a goal or objective that we wish ...

) given available inputs.

Standards of thought

There are two main standards of thought on economic efficiency, which respectively emphasize the distortions created by ''governments'' (and reduced by ''decreasing'' government involvement) and the distortions created by ''markets'' (and reduced by ''increasing'' government involvement). These are at times competing, at times complementary—either debating the ''overall'' level of government involvement, or the effects of ''specific'' government involvement. Broadly speaking, this dialog takes place in the context of

economic liberalism Economic liberalism is a political and economic ideology that supports a market economy based on individualism and private property in the means of production. Adam Smith is considered one of the primary initial writers on economic liberalism ...

neoliberalism Neoliberalism is a political and economic ideology that advocates for free-market capitalism, which became dominant in policy-making from the late 20th century onward. The term has multiple, competing definitions, and is most often used pe ...

, though these terms are also used more narrowly to refer to particular views, especially advocating laissez faire. Further, there are differences in views on microeconomic versus macroeconomic efficiency, some advocating a greater role for government in one sphere or the other.

Allocative and productive efficiency

A market can be said to have

allocative efficiency Allocative efficiency is a state of the economy in which production is aligned with the preferences of consumers and producers; in particular, the set of outputs is chosen so as to maximize the Economic surplus, social welfare of society. This is a ...

if the price of a product that the market is supplying is equal to the marginal value consumers place on it, and equals marginal cost. In other words, when every good or service is produced up to the point where one more unit provides a

marginal benefit Marginal utility, in mainstream economics, describes the change in ''utility'' (pleasure or satisfaction resulting from the consumption) of one unit of a good or service. Marginal utility can be positive, negative, or zero. Negative marginal utilit ...

to consumers less than the marginal cost of producing it. Because productive resources are scarce, the resources must be allocated to various industries in just the right amounts, otherwise too much or too little output gets produced. When drawing diagrams for

business Business is the practice of making one's living or making money by producing or Trade, buying and selling Product (business), products (such as goods and Service (economics), services). It is also "any activity or enterprise entered into for ...

es, allocative efficiency is satisfied if output is produced at the point where marginal cost is equal to average revenue. This is the case for the long-run equilibrium of

perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...

. Productive efficiency occurs when units of goods are being supplied at the lowest possible average total cost. When drawing diagrams for businesses, this condition is satisfied if the equilibrium is at the minimum point of the average total cost curve. This is again the case for the long run equilibrium of perfect competition. For an extensive discussion of many other types of productive efficiency and its measures (Farrell, Hyperbolic, Directional, Cost, Revenue, Profit, Additive, etc.) and their relationships.

Mainstream views

The mainstream view is that market economies are generally believed to be closer to efficient than other known alternativesEconomics, fourth edition, Alain Anderton, p281 and that government involvement is necessary at the macroeconomic level (via

fiscal policy In economics and political science, fiscal policy is the use of government revenue collection ( taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...

and

monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rat ...

) to counteract the

economic cycle Business cycles are intervals of general Economic expansion, expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general po ...

– following

Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomics, macroeconomic theories and Economic model, models of how aggregate demand (total spending in the economy) strongl ...

. At the microeconomic level there is debate about how to achieve efficiency, with some advocating

laissez-faire ''Laissez-faire'' ( , from , ) is a type of economic system in which transactions between private groups of people are free from any form of economic interventionism (such as subsidies or regulations). As a system of thought, ''laissez-faire'' ...

, to remove government distortions, while others advocate regulation, to reduce market failures and imperfections, particularly via internalizing externalities. The first fundamental welfare theorem provides some basis for the belief in efficiency of market economies, as it states that any perfectly competitive market equilibrium is Pareto efficient. The assumption of perfect competition means that this result is only valid in the absence of market imperfections, which are significant in real markets. Furthermore, Pareto efficiency is a minimal notion of optimality and does not necessarily result in a socially desirable distribution of resources, as it makes no statement about equality or the overall well-being of a society.Barr, N. (2004). ''Economics of the welfare state''. New York, Oxford University Press (USA).Sen, A. (1993)
Markets and freedom: Achievements and limitations of the market mechanism in promoting individual freedoms
''Oxford Economic Papers, 45''(4), 519–541.

Schools of thought

Advocates of limited government, in the form

(little or no government role in the economy) follow from the 19th century philosophical tradition

classical liberalism Classical liberalism is a political tradition and a branch of liberalism that advocates free market and laissez-faire economics and civil liberties under the rule of law, with special emphasis on individual autonomy, limited governmen ...

. They are particularly associated with the mainstream economic schools of

classical economics Classical economics, also known as the classical school of economics, or classical political economy, is a school of thought in political economy that flourished, primarily in Britain, in the late 18th and early-to-mid 19th century. It includ ...

(through the 1870s) and

neoclassical economics Neoclassical economics is an approach to economics in which the production, consumption, and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a go ...

(from the 1870s onwards), and with the heterodox

Austrian school The Austrian school is a Heterodox economics, heterodox Schools of economic thought, school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivat ...

. Advocates of an expanded government role follow instead in alternative streams of progressivism; in the

Anglosphere The Anglosphere, also known as the Anglo-American world, is a Western-led sphere of influence among the Anglophone countries. The core group of this sphere of influence comprises five developed countries that maintain close social, cultura ...

(English-speaking countries, notably the United States, United Kingdom, Canada, Australia and New Zealand) this is associated with

institutional economics Institutional economics focuses on understanding the role of the Sociocultural evolution, evolutionary process and the role of institutions in shaping Economy, economic Human behavior, behavior. Its original focus lay in Thorstein Veblen's instin ...

and, at the macroeconomic level, with

. In Germany the guiding philosophy is Ordoliberalism, in the Freiburg School of economics.

Microeconomic reform

Microeconomic reform Microeconomic reform (or often just economic reform) comprises policies directed to achieve improvements in economic efficiency, either by eliminating or reducing distortions in individual sectors of the economy or by reforming economy-wide polic ...

is the implementation of policies that aim to reduce economic distortions via deregulation, and move toward economic efficiency. However, there is no clear theoretical basis for the belief that removing a market distortion will always increase economic efficiency. The theory of the second best states that if there is some unavoidable market distortion in one sector, a move toward greater market perfection in another sector may actually decrease efficiency.

Criteria

Economic efficiency can be characterized in many ways: *

Allocative efficiency Allocative efficiency is a state of the economy in which production is aligned with the preferences of consumers and producers; in particular, the set of outputs is chosen so as to maximize the Economic surplus, social welfare of society. This is a ...

* Distributive efficiency * Dynamic efficiency * Kaldor–Hicks efficiency * Operational efficiency *

* Productive efficiency * Optimisation of a

social welfare function In welfare economics and social choice theory, a social welfare function—also called a social ordering, ranking, utility, or choice function—is a function that ranks a set of social states by their desirability. Each person's preferences ...

Utility In economics, utility is a measure of a certain person's satisfaction from a certain state of the world. Over time, the term has been used with at least two meanings. * In a normative context, utility refers to a goal or objective that we wish ...

maximization * X-inefficiency Applications of these principles include: *

Efficient-market hypothesis The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis ...

* Production theory basics *

Welfare economics Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society. The principles of welfare economics are often used to inform public economics, which focuses on the ...

References

External links

"Efficiency"
article by Paul Heyne {{Authority control Microeconomics Economic reforms