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Allocative efficiency
From Wikipedia, the free encyclopedia
Allocative efficiency is the market condition whereby resources are allocated in a way that maximizes the net benefit attained through their use. Allocative efficiency refers to a situation in which the limited resources of a country are allocated in accordance with the wishes of consumers. An allocatively efficient economy produces an "optimal mix" of commodities. A firm is allocatively efficient when its price is equal to its marginal costs (that is, P = MC) in a perfect market.
A firm is allocatively efficient when its price is equal to its marginal costs (P = MC).
A market will be allocatively efficient if it is producing the right goods for the right people at the right price. An allocatively efficient market is therefore one which has no imperfections. This will be true when marginal cost is equal to average revenue in the market. It occurs where a firm produces at MC = AR (marginal cost pricing). That is to say, in a situation where society produces goods and services at minimum cost that are wanted by consumers, the market is allocatively efficient.
If a market or firm is not Pareto efficient, then it cannot be allocatively efficient. If somebody could be made better off without making any other individual worse off, then clearly net benefit is not maximized, and therefore the market is not allocatively efficient. In the same way, an allocatively efficient market or firm is Pareto efficient - net benefit is maximized, therefore no individual can be made better off without another individual being made at least as worse off. However, it is possible to have Pareto efficiency without allocative efficiency. This occurs when the gain in benefit to one individual is greater than the loss in benefit to another individual.
When a market fails to achieve allocative efficiency and resources are not allocated efficiently, there is said to be market failure. Market failure may occur with imperfect knowledge, differentiated goods, resource immobility, concentrated market power, insufficient production, externalities, or inequality of consumers' and producers' bargaining powers.