Cambridge International as and a level Economics Ebook

 
when a firm is producing at the 
lowest possible cost.
Allocative eff iciency: 
where price is equal to marginal 
cost; firms are producing those goods and services most 
wanted by consumers.
KEY TERMS
130
Cambridge International A Level Economics

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Equilibrium and eff iciency, scarcity and choice: 
The 
above examples and the earlier explanation of diff erent 
types of eff iciency are underpinned by the fundamental 
problem in economics. Since resources are scarce, it is 
essential that they are used in the most eff icient way in 
order to maximise what is produced to benefit producers 
and consumers.
KEY CONCEPT LINK
Productive eff iciency
For productive effi
ciency to exist, goods and services 
must be made using the least possible resources and at the 
minimum possible cost. Productive effi
ciency can be shown 
through a fi rm’s average cost curve as shown in 
Figure 6.1
.
Th
e production possibility curve, which was 
introduced in 
Chapter 1
, will help to clarify productive 
effi
ciency. Th
is curve shows the maximum production 
points for combinations of any two products (e.g., capital 
goods and consumer goods produced in an economy). 
Given this, productive effi
ciency can only exist when 
an economy is producing right on the boundary of its 
production possibility frontier as in 
Figure 6.2
. Th
e 
problem with point 
X
is that more products could be made 
with the resources available. In other words, the goods are 
not being produced using the least possible resources: this 
is productive ineffi
ciency. At point 
Y
, it is not possible to 
produce any more because of the scarce resources that are 
available to the economy. Th
e minimum possible resources 
are being used to make the products. Th
is is thus a point of 
productive effi
ciency.
Competition can be seen to lead to productive 
effi
ciency. In general terms, this is the case as fi rms are 
constrained to produce at the lowest possible cost in a 
competitive market. Firms have the incentive of profi t to 
make their products at the lowest possible cost: the lower 
the cost, the greater the possible profi t. Alternatively, 
a failure to produce at the lowest possible cost in a 
competitive market may lead to bankruptcy for a fi rm. 
As rivals will produce at lowest cost, the price for the fi rm 
that has failed to minimise costs will be too high and thus 
there will be low demand.
More specifi cally, it can be seen that perfect competition 
leads to the necessary conditions for productive effi
ciency 
(see 
Chapter 7
 for details of perfect competition), as shown 
in 
Figure 6.3.
Th
e point of long-run equilibrium for a perfectly 
competitive fi rm is given by price 
p
and output 
q
. At this 
point, it can be seen that the fi rm is producing at the 
lowest point on its average cost curve. Th
is means that 
there is productive effi
ciency. Given that the competition 
in this market will also constrain fi rms to be producing at 
the lowest possible point on their average cost curve, then 
production at this point is productively effi
cient.