Loading the player...

What is 'Economic Efficiency'

Economic efficiency implies an economic state in which every resource is optimally allocated to serve each individual or entity in the best way while minimizing waste and inefficiency. When an economy is economically efficient, any changes made to assist one entity would harm another. In terms of production, goods are produced at their lowest possible cost, as are the variable inputs of production.

BREAKING DOWN 'Economic Efficiency'

Some terms that encompass phases of economic efficiency include allocational efficiency, production efficiency and Pareto efficiency. A state of economic efficiency is essentially theoretical; a limit that can be approached but never reached. Instead, economists look at the amount of loss, referred to as waste, between pure efficiency and reality to see how efficiently an economy is functioning.

Economic Efficiency and Scarcity

The principles of economic efficiency are based on the concept that resources are scarce. Therefore, there are not enough resources to have all aspects of an economy functioning at their highest capacity at all times. Instead, the scarce resources must be distributed to meet the needs of the economy in an ideal way while also limiting the amount of waste produced. The ideal state is related to the welfare of the population as a whole with peak efficiency also resulting in the highest level of welfare possible based on the resources available.

Economic Efficiency and Welfare

Measuring economic efficiency is often subjective, relying on assumptions about the social good, or welfare, created and how well that serves consumers. At peak economic efficiency, the welfare of one cannot be improved without subsequently lowering the welfare of another. In this regard, welfare relates to the standard of living and relative comfort experienced by members within the economy.

Even if economic equilibrium is reached, the standard of living of all individuals within the economy may not be equal. Pareto’s efficiency does not include issues of fairness or equality amongst those within a particular economy. Instead, the focus is purely on reaching a point of optimal operation in regards to the use of limited or scarce resources.

Factors for Analysis of Economic Efficiency

Basic market forces like the level of prices, employment rates and interest rates can be analyzed to determine the relative improvements made toward economic efficiency from one point in time to another. The amount of waste during the production of goods and services can also be considered if the current allocation of resources is ideal in regards to consumer demand.

RELATED TERMS
  1. Efficiency

    A level of performance that describes a process that uses the ...
  2. Production Efficiency

    1. An economic level at which the economy can no longer produce ...
  3. Welfare Economics

    A branch of economics that focuses on the optimal allocation ...
  4. Pareto Efficiency

    An economic state where resources are allocated in the most efficient ...
  5. Allocational Efficiency

    A characteristic of an efficient market in which capital is allocated ...
  6. Price Efficiency

    The premise that asset prices are efficient, to the extent that ...
Related Articles
  1. Insights

    Explaining Economic Efficiency

    Economic efficiency is achieved when every resource is optimally allocated to minimize waste and best serve each person in that economy.
  2. Small Business

    Explaining Efficiency

    Efficiency refers to the ability to make something with the fewest resources possible.
  3. Investing

    Market Efficiency Basics

    Market efficiency theory states that a stock’s price will fully reflect all available and relevant information at any given time.
  4. Investing

    Explaining Pareto Efficiency

    Pareto efficiency is an economic state where resources are allocated in the most efficient manner.
  5. Investing

    Understanding Production Efficiency

    Production efficiency is the point at which an economy cannot increase output of a good or service without lowering the production of another product.
  6. Investing

    Efficiency Ratio

    There are many types of efficiency ratios, but all measure how well a company utilizes its resources to make a profit. Business managers use these ratios to determine how well they are operating ...
  7. Investing

    Efficient Market Hypothesis: Is The Stock Market Efficient?

    Deciding whether it's possible to attain above-average returns requires an understanding of EMH.
  8. Personal Finance

    Economics 101

    Economics is the study of how individuals, governments, businesses and other organizations make choices that effect the allocation and distribution of scarce resources.
  9. Insights

    Is Infinite Economic Growth on a Finite Planet Possible?

    While the finite nature of Earth's resources limits the direction of economic growth, it does not mean that infinite economic growth is impossible.
  10. Insights

    Explaining Minimum Efficient Scale

    Minimum efficient scale is the smallest amount of production a firm can achieve while still taking full advantage of economies of scale.
RELATED FAQS
  1. Does a high efficiency ratio mean that the company is profitable?

    Understand the variety of efficiency ratios and why a high efficiency ratio does not necessarily mean a company is operating ... Read Answer >>
  2. Is Pareto Efficiency the same thing as perfect competition?

    Find out how a perfectly competitive market should lead to Pareto efficiency, at least according to standard neoclassical ... Read Answer >>
  3. What is an efficient market and how does it affect individual investors?

    When people talk about market efficiency they are referring to the degree to which the aggregate decisions of all the market's ... Read Answer >>
  4. How have portfolios from within the efficient frontier performed historically?

    Explore how the efficient frontier is used in selecting investment portfolios. Find out how risks and returns are used to ... Read Answer >>
  5. Which financial ratios are considered to be efficiency ratios?

    Learn about efficiency ratios, what financial ratios are considered efficiency ratios, and how to calculate three different ... Read Answer >>
  6. What is the difference between efficiency ratios and profitability ratios?

    Learn about efficiency and profitability ratios, what these ratios measure and the main difference between efficiency and ... Read Answer >>
Hot Definitions
  1. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  2. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  3. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  4. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  5. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  6. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
Trading Center