HON 222/422

Topic Three:  Efficiency

Sources:  Various sources – see cites in text, Murray Rothbard article

Efficiency is one of the most important concepts in economics.  And actually economists have more than one type of efficiency they talk about – although the most important one in mainstream economics is Pareto optimality (which basically is a form of welfare economics). 

Here are some of the most popular types of efficiency in mainstream economics:

Productive
Productive efficiency focuses on how much output can be produced from a given stock of resources.  An economic entity (person, firm or country) is said to be productively efficient if they are using the “least cost” manner of production.  Cost here is usually measured in some physical form – Deb uses 2 hours (resource) to produce a widget, while Bob uses 3 hours --
Deb is more productively efficient.

Absolute Advantage - one is said to have a absolute advantage if they are more productively efficient than someone else.

Allocative

Allocative efficiency is achieved when resources are allocated to their highest valued use. This is measured by the value consumers place on a good or service (reflected in the price they are willing to pay). The idea is that when the resource goes to the highest bidder – this is its highest valued use (its opportunity cost is lower).  When this condition is satisfied, total economic welfare is maximized.

Comparative Advantage - one is said to have a comparative advantage if they can produce something with a lower opportunity cost.  This is then used to allocate where resources should go.  They should be used in that activity in which they have a comparative advantage.

Pareto Optimality

Pareto defined allocative efficiency as a situation where no one could be made better off without making someone else at least as worse off. An allocation is Pareto efficient or Pareto optimal when no further Pareto improvements can be made – in other words, when no one can be made better off without making someone else worse off.

Trade is often considered a Pareto optimal move since both parties give up something they value in exchange for something they value more.  Both are made better off – no one is made worse off.

This only considers the two parties trading, however.  So it takes a very narrow view.

The Production Possibilities Frontier

In mainstream economics, the PPF model is often used to demonstrate efficiency:

All points that lie on the PPF can be said to be productively efficient – we are using all resources and the best technology – all points are considered equally “productive.” 

Furthermore, the frontier also represents allocative efficiency (Pareto optimal) because we cannot produce more of one product without affecting the amount of all other products available.

Point A is allocatively efficient - but at B we can increase production of both goods by making fuller use of existing resources or increasing the efficiency of production.

Note all of the assumptions behind this model –

1)    More is better

2)    Wealth = production of goods and services

3)    Value of what people want is left out of the model

Social Efficiency (welfare economics)

The socially efficient level of output and or consumption occurs when social marginal benefit = social marginal cost. At this point we maximize social economic welfare. The presence of externalities means that the private optimum level of consumption / production often differs from the social optimum.

In the diagram above the social optimum level of output occurs where social marginal cost = social marginal benefit (point B). A private producer not taking into account the negative production externalities might choose to maximize their own profits at point A (where private marginal cost = private marginal benefit).

This divergence between private and social costs of production is what Rothbard was discussing in your reading.

Rothbard's Analysis:

Rizzo - efficiency can't be separated from ends:

Rothbard - correct but:

1. problem of specifying ends and deciding whose ends should be pursued

2. individual ends are bound to conflict - additive concepts are meaningless

3. even each individual's actions cannot be assume to be "efficient"

why?

Maximizing GDP?  What about externalities?

Theoretically - how might we define efficiency (although there might be no way to operationally actually know it)?

The idea of cost - benefit = adding up the costs and/or benefits and then determining some sort of "social welfare"  or "social cost"?

1. Should social costs be minimized? 

2. If so, how absolute should this commitment be?

3. Fallacy of the concept of social cost - costs can't be added, measured, compared and are not observable by an outside party - and they are transitory.

So what must our decisions regarding policy, law, rights, etc. be based upon?

Rothbard concludes:  ethics and justice.