Allocative efficiency
Topic: Market Structures, Market Failure and Competition · NCERT: Beyond NCERT
Meaning
Allocative efficiency means society produces the mix of goods it values most. The test is P = MC. The price shows what buyers value the last unit at, and marginal cost (MC) shows what that unit costs society to produce. When the two are equal, no reshuffling of resources can raise total welfare.
If P > MC, too little is produced. A perfectly competitive firm sets P = MC, so it is allocatively efficient. A monopoly sets P > MC, so it is not.
Example
Take demand of P = 100 − Q and MC = 20. At the efficient output of 80 units, price is 20. A monopolist produces only 40 units and charges 60, which creates a deadweight loss of 800. Deadweight loss is the surplus that nobody gets.
Don't confuse with
- Productive efficiency: producing at the lowest average cost, the minimum point of the AC curve. It is about how cheaply goods are made. Allocative efficiency is about which goods, and how much of each.
Related concepts
- Pareto efficiency
- Pareto improvement
- Productive efficiency
- Welfare economics
- Kaldor-Hicks efficiency
- Social welfare function
- Theory of the second best