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.