Productive Efficiency

Productive efficiency refers to a firm's costs of production and can be applied both to the short and long run. It is achieved when the output is produced at minimum average total cost (AC). For example we might consider whether a business is producing close to the low point of its long run average total cost curve. When this happens the firm is exploiting most of the available economies of scale. Productive efficiency exists when producers minimise the wastage of resources in their production processes.

Trade-offs between efficiency and equity

There is often a trade-off between economic efficiency and equity. Efficiency means that all goods or services are allocated to someone (there’s none left over). When a market equilibrium is efficient, there is no way to reallocate the good or service without hurting someone. Equity concerns the distribution of resources and is inevitably linked with concepts of fairness and social justice. A market may have achieved maximum efficiency but we may be concerned that the "benefits" from market activity are unfairly shared out.

Social Efficiency

The socially efficient level of output and or consumption occurs when social marginal benefit = social marginal cost. At this point we maximise social economic welfare. The presence of externalities means that the private optimum level of consumption / production often differs from the social optimum.

In the diagram above the social optimum level of output occurs where social marginal cost = social marginal benefit (point B). A private producer not taking into account the negative production externalities might choose to maximise their own profits at point A (where private marginal cost = private marginal benefit). This divergence between private and social costs of production can lead to market failure.

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Attached Images

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