Productive and Allocative Efficiency: Study with Video Lessons, Practice Problems & Examples

Efficiency in microeconomics encompasses productive efficiency, where maximum output is achieved at the lowest cost, and allocative efficiency, which aligns production with consumer preferences. Points along the production possibility frontier indicate productive efficiency, while the correct mix of goods reflects allocative efficiency. Equality addresses the fair distribution of economic benefits, raising ethical considerations in production choices. Understanding these concepts is crucial for analyzing resource allocation and economic policies.

Efficiency and Productive Efficiency

Now we'll discuss the ideas of efficiency and equality and how they relate to microeconomics. So first, we'll talk about Efficiency, and that means that a society is getting the maximum benefits from its scarce resources. Right? And when we talk about efficiency, we're usually referring to productive efficiency, which is essentially the same definition as maximizing output at the lowest possible cost. We're getting the maximum benefits from the scarce resources. Right? So I'm going to take this example to, so you can understand productive efficiency. Let's take it to this graph, and I'm going to introduce a graph that we're going to deal with a lot more later, but I'm just going to kind of deal with it on a high level, no math here, just kind cf discuss this concept of efficiency. Okay. And here we're going to see the economy very similar, to, you know, what you might find at one of your universities here. Right? So at this economy, everything they produce is either deep dish pizzas or light beer. Okay? And let's say they took all of their efforts and produced only light beer. Right? Maybe they could produce this much light beer and no pizza. They could also take all their effort and put it into pizzas and make no light beer, and let's say they could end up somewhere around this point. They could also, you know, split their production to have a mix of light beer and pizza, and they could end up basically anywhere along this line here. So, they could be maybe somewhere here and producing some pizza and some light beer. Right? And I want to show you something about this graph is actually that you can also be producing say in here maybe at this point, but at that point, yes, we're producing some pizza and some beer, but we could have expanded our production and still had resources to do it. We could have, you know, made more pizza or we could have made more beer with our same resources. So the idea is that this point in here, we're going to call this point, let me go back to red. We're going to call this point inefficient because we could have gotten more from our same resources. Right? And we'll call these points along the line. So I'm going to trace the line in black here to show you what I'm talking about. This line, along that line, that is our productive efficiency. That is where we are being productively efficient, we could say. Right? So productive efficiency. Whoops. Let me get my pen back. Productive efficiencies. Anywhere along that line. Right? We could be producing all this light beer up at the top and no pizza and it'll be productively efficient or anywhere along that line or only all those deep dish pizzas and no beer, all of it's productively efficient. And the idea of it being attainable or unattainable, So the idea of anything inside this curve so anything I'm going to highlight here in yellow, this is all attainable to us. Right? These are all production, mixes that we can attain with our resources. And then everything out here is unattainable. Right? We there's no way we could make more than that one. That's just further than that's just more than our resources will allow. Okay? So inside that yellow area, I'll put it out here, the yellow area is attainable because we have the resources to do it, and that blue area is unattainable with our current resources. And we're going to dive into that more. Right? The idea here is that we're reaching efficiency when we're along that line.

Allocative Efficiency

So now let's talk about this other type of efficiency, allocative efficiency. And this is that production represents consumer preferences. Okay? So before we were talking about making the most with what we had, this is more about making the correct mix of stuff based on our consumers. Right? It's a bit more subjective. You can't be expected to just know what the consumers want. This is kind of information that's going to be given to you on the test, and then you'll have to find the point of allocative efficiency or something like that. So, as an example here on our graph, let's talk about a couple of different schools and their allocative efficiency point, right? Maybe you're at a school like FSU. Big party school, right, loves their cheap beer. Right? And they might find that their most allocatively efficient point on the graph might be somewhere around here. Right? Point a on the graph. Lots of light beer, lots of cheap beer, no pizza. Pizza is not a worry. They don't need sustenance. They can get by just on the beer here. So FSU, let's put something like lots of beer, no pizza. So their allocative efficiency point would be somewhere around point A, right? They're still productively efficient, but they're just making the right stuff for their consumers.

What if you're at a school like NYU where they have really good pizza, where, oh, well, I put deep dish pizza. So this should really be some kind of Chicago school. So let's say you're at University of Illinois in Chicago, right, and you still like beer. Right? You still need your cheap beer because you're in college. You can't afford the good stuff, but you still need pizza too. Right? You've got that really good pizza, so your allocative efficiency point might be somewhere here in the middle where you're getting some pizza and some beer, right? So let's write that in here. Some pizza, some beer, point B. So, both of these points reach allocative efficiency. Here, sorry. Let me get out of the way there. Both of these points do reach allocative efficiency. It's just a matter of the consumer preference. Right? What do the consumers want? And that's what we're going to produce. So why don't we move on to the next video?

Equality

So let's move on to the next topic here, the idea of equality, right? We've been talking about efficiency to this point, right? How do we make the right stuff? How do we make as much as possible? But this is more about the distribution of this production. Equality is talking about the fair distribution of the economic benefits. Right? So the idea of getting my fair share. And in this course, we're definitely going to be spending a lot more time on efficiency than equality, but it is going to come up when we're dealing with, you know, policymaking, and government intervention in the market, things like that. But let's look at our example; you know, equity a lot of times it has to do with ethics too, you know. Maybe is it even ethical, you know, to produce at point A? You know, these people that only have beer and no sustenance. Yes. I know the Seminoles can get by in that lifestyle, but is it ethical? Right? These kinds of questions, that's what we're dealing with when we're talking about equality. Not really key to this course, but you'll see that it is important to economics to make sure that the distribution of resources is also happening in an equitable way. Cool. So let's move on.

Here’s what students ask on this topic:

What is productive efficiency in microeconomics?

Productive efficiency in microeconomics refers to a situation where a society is maximizing its output from its scarce resources. This means producing goods and services at the lowest possible cost. On a production possibility frontier (PPF), productive efficiency is represented by any point along the curve. These points indicate that the economy is using all its resources efficiently to produce a mix of goods. If production occurs inside the PPF, it is considered inefficient because more output could be achieved with the same resources.

How does allocative efficiency differ from productive efficiency?

Allocative efficiency differs from productive efficiency in that it focuses on producing the right mix of goods and services that align with consumer preferences. While productive efficiency is about maximizing output at the lowest cost, allocative efficiency ensures that the resources are used to produce the combination of goods and services most desired by consumers. For example, a college town might allocate more resources to producing beer if that is what students prefer, achieving allocative efficiency even if the production is still productively efficient.

What is the production possibility frontier (PPF) and how does it relate to efficiency?

The production possibility frontier (PPF) is a graph that shows the maximum possible output combinations of two goods that an economy can achieve using its resources efficiently. Points along the PPF represent productive efficiency, where resources are fully utilized. Points inside the PPF indicate inefficiency, as more output could be produced with the available resources. Points outside the PPF are unattainable with the current resources. The PPF helps illustrate the trade-offs and opportunity costs involved in production decisions.

Why is equality important in the context of economic efficiency?

Equality is important in the context of economic efficiency because it addresses the fair distribution of economic benefits. While efficiency focuses on maximizing output and aligning production with consumer preferences, equality ensures that the benefits of production are distributed fairly among all members of society. This involves ethical considerations, such as whether it is fair for some individuals to have access to certain goods while others do not. Policymakers often need to balance efficiency with equality to create a more just and equitable economy.

Can an economy be both productively and allocatively efficient?

Yes, an economy can be both productively and allocatively efficient. Productive efficiency occurs when an economy is producing the maximum output at the lowest cost, represented by points along the production possibility frontier (PPF). Allocative efficiency occurs when the mix of goods and services produced aligns with consumer preferences. An economy achieves both types of efficiency when it operates on the PPF and produces the combination of goods and services that consumers most desire. This ensures that resources are used optimally and in a way that maximizes overall satisfaction.