1. ALLOCATIVE & PRODUCTIVE EFFICIENCY
Ellie Tragakes – Economics for the IB Diploma Program (2009) & Blink & Dorton (2011) – Economics A Course Companion

2. Productive Or Technical Efficiency
Occurs when the firms produces at the lowest possible cost.
The condition for productive efficiency is given by P = minimum average total cost. (ATC) or when MC = AC.
Production of the good uses up the least amount of resources possible.
In the long run, price will equal the Average Total Cost.

3. How is productive efficiency different to profit maximizing level of output?
Profit Maximizing Level of Output = Marginal Revenue (MR) = Marginal Cost (MC) Productive Efficiency Marginal Cost (MC) = Average Cost (AC)
In perfect competition, in the long run, both of these are the same. Why?

4. PRODUCTIVE EFFICIENCY
At the output q, the firm is able to produce at the most efficient level of output – the lowest average cost of production. This is the cost c. So q is known as the productively efficient level of output. We know that MC always cuts the AC at its lowest point.
The Productively Efficient Level is MC=AC.

5. Allocative Efficiency
Allocative efficiency occurs when firms produce the particular combination of goods and services that consumers most prefer.
In other words, the forces of supply and demand work perfectly in the allocation of resources – not real world stuff!!, but it is important.
It is achieved in perfect competition, but not in other situations.
With allocative efficiency, consumer and producer surplus are maximized.
What is consumer and producer surplus??

6. Consumer Surplus
Consumer surplus is defined as the highest price consumers are willing to pay for a good minus the price actually paid
Consumer surplus indicates that whereas many consumers were willing to pay a higher price to get the good, they actually received it for less.

7. CONSUMER SURPLUS EXPLAINED
Consumer surplus indicates that whereas many consumers were willing to pay a higher price to get the good, they actually received it for less. Eg. Some consumers were willing to pay P2 in for quantity Qa. Yet they got Qa by paying the lower price Pe. The difference between P2 and Pe is the consumer surplus for quantity Qa. We can also talk about a consumer surplus for P3 also.

8. Producer Surplus
Producer surplus is defined as the price received by firms for selling their goods minus the lowest price that they are willing to accept in order to produce the good.
The lowest price they are willing to accept represents the firms cost of producing an extra unit of the good (or marginal cost) and is shown by the supply curve

9. Why is it called producer surplus?
PRODUCER SURPLUS EXPLAINED
Why is it called producer surplus?
Eg: Firms that were willing to produce Qa for price P5 actually received Pe, which is determined in the market. The difference Pe-P5 is the producer surplus for quantity Pa. Therefore producer surplus is shown by the shaded area between the equilibrium price Pe and the supply curve, representing the difference between price received and the marginal cost.
MB=MC

10. Reinterpreting Market Equilibrium to understand Allocative Efficiency
If we think of the demand curve as a marginal benefit (MB) curve and the supply curve as marginal cost curve (MC) curve, then the point of market equilibrium is the point where MB =MC.
When this happens, it means that society’s resources are being use to produce the “right” quantity of the good – in other words society has allocated the “right” amount of resources to the production of the good and is producing the quantity of the good that is mostly wanted by society.

11. Perfect Competition & Allocative Efficiency
In perfect competition, the demand curve is the same as the AR & MR curve
So in perfect competition we can say that allocative efficiency is achieved where:
AR = MC Or MC = AR.

12. Perfect Competition & Allocative Efficiency
Allocative efficiency is achieved with perfect competition, because resources are allocated in the most efficient manner.
A large number of firms ensures that no individual firm can manipulate or control price, and this ensures that market forces work to achieve equilibrium in the long run.

13. Productive & Allocative Efficiency Combined
When the economy achieves both productive and allocative efficiency, the society is said to have achieved economic efficiency (also known as Pareto efficiency or Pareto optimality)

14. PRODUCTIVE AND ALLOCATIVE EFFICIENCY WITH SHORT RUN PROFITS IN PERFECT COMPETITION
If a firm is making abnormal profits in the short run, they are producing at the profit maximising level of output q (where in MC=MR) and the allocatively efficient level of output q2 (where MC=AR) . However, the firm does not achieve productive efficiency (where MC=AC).

15. PRODUCTIVE AND ALLOCATIVE EFFICIENCY WITH SHORT RUN LOSSES IN PERFECT COMPETITION
If a firm is making losses in the short run, they are producing at the profit maximising level of output q (where in MC=MR) and the allocatively efficient level of output q2 (where MC=AR) . However, the firm does not achieve productive efficiency q1 (where MC=AC).

16. PRODUCTIVE AND ALLOCATIVE EFFICIENCY IN THE LONG RUN IN PERFECT COMPETITION
Profit maximising firms in the long run in perfect competition all produce at the lowest point of their long run average cost curves. As we assume that there is perfect knowledge in the industry, all of the firms will face the same cost curves. They are all selling at the same price and minimising their average costs by producing where MC=AC. It should also be noted that all of the profit maximising firms in the long run are also producing at the allocatively efficient level of output, where MC=AR and they also achieve productive efficiency, where MC=AC.

17. Efficiency in Monopoly
Unlike perfect competition, the monopolist produces at the level of output, where there is neither productive efficiency nor allocative efficiency.

18. NO PRODUCTIVE AND ALLOCATIVE EFFICIENCY IN MONOPOLY
The monopolist is producing at the profit maximising level of output, q. Output is being restricted in order to force up the price and to maximise profits.
However, the most efficient level of output, q1 and the allocatively efficient level of output, q2 are not being achieved.

19. Efficiency in Monopolistic Competition
Unlike perfect competition, there is no production and allocative efficiency in monopolistic competition.

20. PRODUCTIVE AND ALLOCATIVE EFFICENCY IN THE SHORT RUN IN MONOPOLISTIC COMPETITION
The graphs above show two possible short run positions in monopolistic competition and abnormal profits and losses. The firm produces at the level of output where profits are maximised, q, as opposed to the productively efficient level of output q1 or the allocatively efficient level of output, q2.

21. PRODUCTIVE AND ALLOCATIVE EFFICENCY IN THE LONG RUN
The firm is again producing at the profit-maximising level of output, q, and not at the productively efficient level of output, q1 or the allocatively efficient level of output q2.

22. Efficiency in Oligopoly
What do you think we can say about efficiency in oligopoly?