Efficiency and Welfare

1) Meaning of economic efficiency

In microeconomics, efficiency typically refers to using resources to maximize total welfare.

Key types:

• Pareto efficiency
• Allocative efficiency
• Productive efficiency
• Dynamic efficiency (innovation over time; sometimes mentioned)

2) Pareto efficiency (recap)

An allocation is Pareto efficient if no Pareto improvement is possible.

• Efficient ≠ equitable.
• Competitive equilibrium is Pareto efficient under standard assumptions (First Welfare Theorem).

3) Allocative efficiency

Allocative efficiency occurs when:

Meaning marginal benefit (as reflected by price in competitive markets) equals marginal cost.

If $P > MC$ (e.g., monopoly):

• output too low relative to efficient level → DWL.

If $P < MC$ (e.g., under-priced goods, some subsidies):

• output too high relative to efficient level → potential overconsumption and welfare loss.

4) Productive efficiency

Productive efficiency means producing output at the lowest possible cost:

• producing at minimum average cost (given technology). In perfect competition long-run:

so productive efficiency holds.

Monopoly/monopolistic competition often fail productive efficiency:

• monopoly: may not produce at minimum AC,
• monopolistic competition: excess capacity.