Allocative Efficiency
Allocative efficiency concerns the quantities of the various products to
be produced. When the combination of goods produced is allocatively
efficient, economists say that the economy is Pareto efficient, in honour of
nineteenth-century Italian economist Vilfredo Pareto (1843–1923), who
developed this concept of efficiency.
How do we find the allocatively efficient point on the production
possibilities boundary? The answer is as follows:
The economy is allocatively efficient when, for each good produced, its marginal cost of
production is equal to its marginal value in consumption (as given by the market price).If the level of output of some product is such that marginal cost to
producers exceeds marginal value to consumers, too much of that product
is being produced, because the cost to society of the last unit produced
exceeds the benefits of consuming it. Conversely, if the level of output of
some good is such that the marginal cost is less than the marginal value,
too little of that good is being produced, because the cost to society of
producing the next unit is less than the benefits that would be gained
from consuming it.
To make this concept more tangible, consider the perfectly competitive
market for product X, as shown in Figure 12-3. The market demand