Efficiency

What Is Efficiency?

The term efficiency refers to the peak level of performance that uses the least amount of inputs to achieve the highest amount of output. Efficiency requires reducing the number of unnecessary resources used to produce a given output, including personal time and energy. It is a measurable concept that can be determined using the ratio of useful output to total input. It minimizes the waste of resources such as physical materials, energy, and time while accomplishing the desired output.

Key Takeaways

  • Efficiency occurs when you reduce waste to produce a given number of goods or services.
  • You can measure efficiency by dividing total output by total input.
  • There are a number of different types of efficiency, including economic efficiency, market efficiency, and operational efficiency.
  • Efficiency is an important attribute because all inputs are scarce.
  • You can measure the efficiency of your investments using the return on investment figure.
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Efficiency

Understanding Efficiency

The term efficiency can be defined as the ability to achieve an end goal with little to no waste, effort, or energy. Being efficient means you can achieve your results by putting the resources you have in the best way possible. Put simply, something is efficient if nothing is wasted and all processes are optimized. This includes the use of money, human capital, production equipment, and energy sources.

Efficiency can be used in a variety of ways to describe various optimization processes. As such, analyzing efficiency can help reduce costs and increase bottom lines. For instance:

  • Corporations can measure the efficiencies of their production process, which can help them cut down costs while increasing output, which can lead to higher sales and revenue.
  • Consumers can purchase energy-efficient appliances to cut down their energy bills while reducing greenhouse gases.
  • Investors can determine the efficiency of their investments by using the return on investment (ROI), which highlights an investment's return relative to how much it costs.

As noted above, efficiency is measurable and can be expressed as a ratio or percentage. You can measure it by using the following formula:

Efficiency = Output ÷ Input

Output (or work output) is the total amount of useful work completed without accounting for any waste and spoilage. If you want to express efficiency as a percentage, simply by multiplying the ratio by 100.

Efficiency measures any performance that uses minimal inputs to get the maximum number of outputs. Put simply, you're efficient if you get more by using less.

Types of Efficiency

Efficiencies can be divided into many different categories. We've outlined some of the key types below, including economic efficiency, market efficiency, and operational efficiency.

Economic Efficiency

Economic efficiency refers to the optimization of resources to best serve each person in that economic state. No set threshold determines the effectiveness of an economy, but indicators include goods brought to market at the lowest possible cost and labor that provides the greatest possible output.

Market Efficiency

Market efficiency describes how well prices integrate available information. This means that markets are efficient when all information is already incorporated into prices. There is no way to beat the market since there are no undervalued or overvalued securities available.

Market efficiency was described in 1970 by economist Eugene Fama, whose efficient market hypothesis (EMH) states that an investor can't outperform the market. Fama also stated that market anomalies should not exist because they will immediately be arbitraged away.

Operational Efficiency

Operational efficiency measures how well profits are earned as a function of operating costs. The greater the operational efficiency, the more profitable the firm or investment. This is because the entity is able to generate greater income or returns for the same or lower cost than an alternative. In financial markets, operational efficiency occurs when transaction costs and fees are reduced.

A Historical Look

Breakthroughs in economic efficiency often coincide with the invention of new tools that complemented labor, including:

  • The horse collar, which redistributes the weight on a horse's back so it can carry large loads without being overburdened
  • The steam engines and motor vehicles that emerged during the Industrial Revolution, which allowed people to travel longer distances in less time and contributed to travel and trade efficiencies
  • Cheaper and more effective sources of power like fossil fuels

We also saw the emergence of efficiencies in time. Consider the factory system, in which each participant focuses on one task in a factory line. This system increased operational output while saving time.

Many scientists developed practices to optimize specific task performance. One famous example is the novel Cheaper by the Dozen by Frank Bunker Gilbreth, Jr. and Ernestine Gilbreth Carey. In the book, Gilbreth Jr. develops systems to maximize efficiency in even the most mundane tasks, such as brushing your teeth.

The Impacts of Efficiency

Efficiency is an important attribute because all inputs are scarce. Time, money, and raw materials are limited, and it is important to conserve them while maintaining an acceptable level of output.

An efficient society is better able to serve its citizens and function competitively. Goods that are produced efficiently are sold at a lower price. Advances as a result of efficiency have facilitated higher standards of living such as supplying homes with electricity, running water, and giving people the ability to travel.

Efficiency reduces hunger and malnutrition because goods are transported farther and quicker. Advances in efficiency also allow greater productivity in a shorter amount of time. 

Example of Efficiency

Industry 4.0 is the Fourth Industrial Revolution characterized by digitalization. Factory processes, manufacturing, and service industries are all more efficient, thanks to more powerful computers, cloud computing, the Industrial Internet of Things (IoT), data analytics, robotics, artificial intelligence, and machine learning.

For example, data analytics can be applied in an industrial setting to inform factory or plant managers when machinery needs maintenance or replacement. This predictive maintenance can substantially reduce operational costs.

Research from Accenture cited by Jay Lee, Chao Jin, Zongchang Liu, and Hossein Davari Ardakani in their paper "Introduction to Data-Driven Methodologies for Prognostics and Health Management" shows that using data analytics for predicted maintenance leads to a 30% drop in costs and 70% less equipment downtime. Managers can identify and fix inefficient systems using real-time data logging and the historical data built up over time.

How Do You Calculate Efficiency?

Efficiency can be expressed as a ratio by using the following formula: Output ÷ Input.

Output, or work output, is the total amount of useful work completed without accounting for any waste and spoilage.

You can also express efficiency as a percentage by multiplying the ratio by 100.

What Is Allocative Efficiency?

Allocative efficiency occurs in an efficient market. This is where capital is allocated in the best way possible to benefit each party involved. It allows for the even distribution of goods and services, financial services, and other key elements to consumers, businesses, and other entities so they can be used in the best way possible. Allocative efficiency, which is also referred to as allocated efficiency, facilitates decision-making and economic growth.

What Is Peak Efficiency?

Peak energy is the highest level of efficiency you can reach. This kind of efficiency occurs when all capital, resources, and individual participants are properly allocated and fully functional to the best of their ability. For instance, peak economic efficiency occurs when the economy is productive and the standard of living for citizens is high.

What Is Energy Efficiency?

Energy efficiency occurs when you use less energy to achieve the same result. Being energy efficient reduces energy waste and greenhouse gases, as well energy demand. It also helps cut down on bills and overall costs using new and more efficient ways to consume energy.

For example, consumers can purchase energy-efficient appliances to cut down on their energy bills while corporations may swap out older production equipment with new, more efficient ones to increase output while cutting down on production costs.

What Is a Measure of Efficiency in an Investment?

An investment's measure of efficiency is its return on investment. This is the way investors and financial professionals measure how efficiently an investment makes a profit. This metric can also be used to compare one investment to another or multiple investments in a particular class, such as mutual funds that invest in the same asset class. ROI can be expressed as a ratio by dividing an investment's return by its cost. It can also be expressed as a percentage by multiplying the result by 100.

The Bottom Line

When you're efficient, it means that you're able to achieve your goals with as little money and effort as possible without producing too much waste. Essentially, you use very little to get the biggest result possible.

Efficiency is important for businesses and individuals alike. Businesses that run efficiently can reduce their costs and improve their bottom lines. Similarly, consumers who make choices to become more efficient, such as choosing energy-efficient appliances or investments that have the best possible returns while serving their investment needs, end up saving money and making more in the long run.

If you need proof, just use the formula noted above and use it as a guideline to help you make some important decisions about your financial health.

Article Sources

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  2. ResearchGate. "Introduction to Data-Driven Methodologies for Prognostics and Health Management," Page 10. Accessed Oct. 1, 2021.