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In this video you will learn how:
- To define the term ‘allocative efficiency’.
- To represent the concept of productive efficiency on two diagrams:
the production possibilities curve (PPC)
the market equilibrium diagram
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In this video covering the A2 specification we will learn about the concept of allocative efficiency.
By the end of this video you will be able to define the term allocative efficiency and be able to demonstrate it on both the PPC and the market equilibrium diagram.
Whereas productive efficiency is primarily concerned with making the most use out of available resources, allocative efficiency is more concerned about how those resources are allocated, specifically with regard to society’s preferences.
It occurs when the marginal benefit for a good is equal to its marginal cost of production.
The price consumers are willing to pay should be equal to the opportunity cost of using those resources in production. It is only at this point that allocative efficiency is achieved.
The PPC here represents the production of an economy split between producing capital goods and consumer goods. Points A, B and C, along the PPF represent the full use of available resources and are therefore productively efficient, but only ONE point is allocatively efficient.
In order to determine the combination that is allocatively efficient, we must determine the combination of goods that best reflects consumers’ preferences. Most likely, producing all capital goods or all consumer goods is not desirable, so our allocatively efficient will be at some point in between.
In this case that combination is represented by point B and therefore all other points are NOT allocatively efficient.
Let’s go back to our original supply and demand diagram and consider the producer perspective when making production decisions. The demand curve in this instance represents the marginal benefit to consumers. The supply curve represents the marginal cost of production to the firm.
As long as the marginal benefit of consuming an additional good is above the marginal cost of producing it, production will increase. This is because the price consumers are willing to pay exceeds the costs faced by the producer. Once the price consumers are willing to pay meets the costs producers face, equilibrium is reached. At this point consumer and producer surplus are maximised. So it is this condition, that marginal benefit or price, is equal to marginal cost that results in allocative efficiency.
Allocative efficiency is a bit of a tricky concept and will become clearer as you progress in your studies at A2. For now, understand the basics introduced in this video and pay close attention to the market structure characteristics in order to learn which ones result in allocative efficiency and which structures don’t.
For now you should be able to define the term allocative efficiency and demonstrate it on both the PPC and the market equilibrium diagram. If you have any questions or comments, leave them below or email me at [email protected]
You can also visit my website at www.enhancetuition.co.uk. That’s us done for now and I will see you in the next one!