3. If too much of one product and too little of another product are
produced, the economy overall is being inefficient. To take an
extreme example, suppose so many shoes are produced that
every consumer has all the shoes he or she could possibly want
and thus places a zero value on obtaining an additional pair of
shoes. Suppose also that so few coats are produced that
consumers place a high value on obtaining an additional coat. In
these circumstances, consumers can be made better off if
resources are reallocated from shoe production, where the last
shoe produced has a low value in the eyes of each consumer, to
coat production, where one more coat produced would have a
higher value to each consumer.These three examples all illustrate inefficiency in the use of resources. But
the type of inefficiency is different in each case. The first example
considers the cost for a single firm producing some level of output. We
refer to this concept as productive efficiency for the firm. The second
example is related, but the focus is on the total cost for all the firms in an
industry. We refer to this concept as productive efficiency for the
industry. The third example relates to the level of output of one product
compared with another. We refer to this concept as allocative efficiency,
and it applies to the overall economy. Let’s explore these three types of
inefficiency in more detail.
Productive Efficiency