Economic efficiency is the use of resources such that maximum utilization of those resources is achieved in production of goods and services. It involves effective and equitable allocation of resources. An economy is said to be economically efficient if any change made to make one agent better off would make a second agent worse off. This condition is known as pareto-efficient condition. Given the same level of economic resources and technology, firm A is said to be efficient than firm B if it produces more output than firm B. efficiency is used to make comparison between what should be produced in actual levels and what is currently produced.
Importance of this approach to the field of policy analysis
Economists use efficiency to determine the performance of an economy given the resources available as compared to the actual level at which it is supposed to operate. Analysts use this approach to estimate and analyze powers of the government and come up with rationale for government relations with the private sector. It is used to evaluate existing policies and compare them with new initiatives for changes recommendations (Varian, 2010).
To start with, in classification of rationales, economists use the concept of perfectly competitive market that is characterized by large numbers of profit maximizing firms, large numbers of utility maximizing consumers, and price determined in the market-by-market forces of demand and supply.
The behavior of economic agents in the market without interference by the government agent could lead to a pareto-efficient allocation. That is, if the market is allowed to operate on its own the level of production will be efficient, such that one cannot make another person better off without making someone else worse off. For instance, lowering prices is likely to make the consumer better off although on the other hand, it could make the producer worse off (Frank, 2010).
It helps economists to recognize the aspect of market failure that violates the basic assumptions of a perfect market. This leads to inefficiency in production and consumption. An example is given by a monopoly market where the monopoly firm produces low levels of commodity and charges very high prices since it is the only producer in the market.
It helps analysts in addressing issues such as equitable resource distribution, political and economic participation and fairness in distribution of resources. A perfect competitive market is an example of a general equilibrium model, this means that the prices of all factor input and the output prices clears the market (Vining, Weimer & Aidan, 2010). Some critics argue that economic approach for efficiency oversimplifies the issue efficiency. In order to address efficiency effectively we need to consider factors such as human dignity, economic opportunity and political participation.
The general equilibrium is usually static whereas the real world is very dynamic since prices and consumer needs keep changing with introduction of new technology in production. General equilibrium however helps policy analysts to realize the gains in social welfare (Varian, 2010). For consumers to maximize their utility, they consume different kinds of commodities that are ranked in terms of preferences. Consumer chooses the optimal attainable consumption level given his income. That is, at the highest point where consumer’s indifference curve touches the budget line and has equal slopes.
Perfect competitive economy provides useful tools for analysis of efficiency, the issues applied in welfare economic, the pareto-efficiency, the market demand and supply analysis and the consumer and producer surplus gives us ideas of investigating and analyzing the complex market. This helps us anticipate the future trends of market prices, demand and supply of goods and service.
Frank, R. (2010). Microeconomics and behavior. (8 ed.). New York, NY: McGraw Hill Irwin.
Varian, H. L. (2010). Intermediate microeconomics: A modern approach. New York, NY: W.W. Norton & Company Incorporated.
Vining, D., Weimer, L. & Aidan, R. (2010). Policy Analysis for Capella University. (5 ed.). Boston, MA: Pearson Learning Solutions.