— Ch. 1 · Defining Efficiency Concepts —
Economic efficiency.
~4 min read · Ch. 1 of 6
In 1935, economist Vilfredo Pareto described a state where any change to help one person would inevitably harm another. This moment created the concept of allocative efficiency within microeconomic theory. A market achieves this status when the price of a product equals the marginal value consumers place on it. It also requires that price matches the marginal cost of production. No additional output of one good can be obtained without decreasing the output of another good in productive efficiency scenarios. Production must proceed at the lowest possible average total cost for this condition to hold true. These definitions are not equivalent. A system may be allocatively efficient while failing to be productively efficient. Engineers define a system as optimal when it maximizes desired outputs given available inputs.
Standards Of Thought
Two main standards of thought exist regarding economic efficiency and government intervention. One standard emphasizes distortions created by governments and suggests reducing involvement to fix them. The other standard highlights distortions created by markets and advocates increasing government involvement to reduce those issues. These perspectives sometimes compete and sometimes complement each other during debates about overall government levels. Broadly speaking, this dialog takes place in the context of economic liberalism or neoliberalism. Some use these terms more narrowly to refer to particular views advocating laissez-faire policies. Differences in views exist between microeconomic versus macroeconomic efficiency spheres. Some advocate a greater role for government in one sphere or the other depending on the specific economic challenge.Mainstream Economic Views
The mainstream view holds that market economies are generally believed to be closer to efficient than other known alternatives. Government involvement is considered necessary at the macroeconomic level via fiscal policy and monetary policy. This approach follows Keynesian economics to counteract the economic cycle. At the microeconomic level there is debate about how to achieve efficiency. Some advocate laissez-faire measures to remove government distortions while others support regulation. Regulation aims to reduce market failures and imperfections particularly via internalizing externalities. The first fundamental welfare theorem provides some basis for belief in market economy efficiency. It states that any perfectly competitive market equilibrium is Pareto efficient. This result is only valid in the absence of market imperfections which are significant in real markets. Pareto efficiency does not necessarily result in a socially desirable distribution of resources as it makes no statement about equality.