EfficiencyLesson 1.8 – Year 12 Economics

‘See how we are doing’ elasticity test You now have 10 minutes to read

through the results of the elasticity test and see how you could gain more marks next time.

If you were the CEO of Apple… Would you aim to make the IPhone 5 at

the lowest possible cost? Or would you aim to make the exact

amount that customers want? What do you think customers want? What do you think happens in reality?

What is the ‘key economic problem’? Economics is the study of the use of

scarce resources in order to meet infinite wants.

I.e. Everybody in the world would love a bmw, an iphone 5 or even 2 warm meals a day, but there is only so much Land, Labour, Capital and Enterprise that exists!

So if we cant meet all wants… We have to find the most effective way

of using those scarce resources to meet the highest possible level of wants.

This is known as efficiency.

Economic Efficiency If resources are being used in the ‘best

possible way’, economists argue there are two different types of efficiency that must be achieved to get economic efficiency…..

1. Productive Efficiency Using the least amount of scarce

resources to produce any particular product.

In other words, producing things at the lowest possible cost.

Price =Lowest Average Total Cost Lets draw a pretty picture…

Productive EfficiencyCosts

Output

Average Cost 1

Average Cost 2

Average Cost 3

X

To be productively effiicient, a business would need to produce at output X, as this is where costs are at their lowest.

Productive Efficiency This assumes firms are using the lowest

cost production techniques available, as they are operating on their lowest cost curve.

It also assumes that they are producing at the lowest possible cost.

What do you think about these assumptions?

2. Allocative Efficiency Allocative efficiency is all to do with

producing those products that are most wanted by consumers, given their cost of production.

Lets see what this means…

Example 1 A can of diet coke and a can of coke

zero costs exactly the same to make. However, if consumers get twice as

much satisfaction from drinking coke zero than diet coke, the company should produce coke zero to be allocatively efficient.

Example 2 Consumers get exactly the same

satisfaction from eating salt and vinegar crisps to eating prawn cocktail crisps.

However, if salt and vinegar crisps costs half as much to produce than prawn cocktail, then the company must produce salt and vinegar to be allocatively efficient.

More precisely.. Allocative efficiency will only occur when

the selling price is the same as the marginal cost of producing that product.

P=MC In this case, the price paid by the

customer is the same as the true economic value i.e. the satisfaction consumers get is equal to how much it costs to make the product…

Marginal Cost The additional cost of producing one more unit of a

good or service. I.e. how much do your total costs rise when your

produce one more unit. If you make 1 iphone it will cost 50p for parts and

50p for labour = £1 – this is the marginal cost compared to producing 0

If you make 2 iphones it will cost 50p for parts, 50p for labour and now you will need to pay overtime of 50p = £1.50 – this is the marginal cost from moving from 1 to 2 iphones.

Essentially, it is your variable costs.

So, where are we allocatively efficient…Quantity 1 2 3 4

Price (£) 5 5 5 5

Marginal Cost (£) 3 4 5 6

Quick Quiz – Allocative/Productive efficiency1. Firm uses a new machine that costs less

than the old one, but produces more.2. A company swaps production to a

different product that sells at the same price, but is in greater demand.

3. A car plant makes 1,000 workers redundant because their jobs can now be done by robots that cost less over a period of time than paying workers wages