What is Allocational Efficiency
Allocational efficiency is a characteristic of an efficient market in which capital is allocated in a way that is most beneficial to the parties involved. An efficient market is one in which all pertinent data regarding the market and its activities is readily available to all market participants and is always reflected in market prices.
Allocational efficiency occurs when parties are able to use the accurate and readily available data reflected in the market to make decisions about how to allocate their resources. When all of the data affecting a market is available for use in decisions, companies can make accurate decisions about what projects might be most profitable and manufacturers can allocate resources to producing products that are most desired by the general population. Allocational efficiency occurs when organizations in public and private sectors spend their resources on projects that will be the most profitable and do the most good for the population, thereby promoting economic growth.
Allocational efficiency can also be called allocative efficiency.
BREAKING DOWN Allocational Efficiency
In order to be allocationally efficient, a market must be efficient. In order for a market to be efficient, it must meet the prerequisites of being both informationally efficient and transactionally or operationally efficient. When a market is informationally efficient, all necessary and pertinent information about the market is readily available to all parties involved in the market. No parties have an informational advantage over any other parties. When a market is transactionally efficient, all transaction costs are reasonable and fair, making all transactions equally executable by all parties. No transaction is prohibitively expensive for any party. If these conditions of fairness are met and the market is efficient, capital flows will direct themselves to the places where they will be the most effective, providing an optimal risk/reward scenario for investors.