Allocative Efficiency1 min read

Allocative efficiency is defined as a situation where a combination of goods and services that maximises society’s welfare is produced and consumed, for a particular distribution of wealth.

In H2 economics, you learn that the free market achieves allocative efficiency in the absence of market failure. This is easily seen from diagrams where you show how the consumer and producer surplus are maximised.

However what is often left unsaid is that even if we have a society where one person owned all the wealth and directed production to only satisfying his own wants, the resulting outcome from markets would still be considered “allocatively efficient”. Clearly, allocative efficiency cannot be the gold standard of welfare.

This necessary implies that it may still be possible to improve society’s welfare by redistributing wealth; in other words, there may be a more desirable combination of goods and services out there that maximises society’s welfare over all distributions of wealth. Of course, in order to define such a point, we will have to bring in ethics and morality; not something that I want to go into detail on this blog. But the point here is to realise that economics is limited and that we cannot meaningfully discuss welfare without answering questions on distribution and ethics.

Some questions for you to think about:

  1. Does allocative efficiency imply productive efficiency? Show it or give a counter example.

  2. Does productive efficiency imply allocative efficiency? Show it or give a counter example.

Till next time, dream economics.

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