Allocative, Productive and Dynamic Efficiency

Statement

The three types of efficiency in the H2 syllabus are:

• Allocative efficiency — society’s resources are distributed to produce the combination of goods and services most desired by society; achieved where price equals marginal cost ($P = MC$), equivalently where $MSB = MSC$.
• Productive efficiency — output is produced at the lowest possible cost, using the fewest resources for a given output.
• Dynamic efficiency — efficiency improves over time through innovation, investment and the development of new products and processes.

Allocative inefficiency is the scenario where resources are not distributed to produce the combination of goods and services most desired by society.

Notes

Allocative efficiency is the type most directly relevant to market failure: the predominant problem with microeconomic market failures is that they produce allocative inefficiency, and hence a deadweight welfare loss. Achieving allocative and productive efficiency — together with equity — constitutes the government’s microeconomic objectives.