Allocative efficiency

Allocative efficiency

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Allocative efficiency is a theoretical measure of the benefit or utility
Utility
In economics, utility is a measure of customer satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service....

 derived from a proposed or actual selection in the allocation or allotment of resources.

Although there are different standards of evaluation for the concept of allocative efficiency, the basic principle asserts that in any economic system, choices in resource allocation produce both "winners" and "losers" relative to the choice being evaluated. The principles of rational choice, individual maximization, utilitarianism
Utilitarianism
Utilitarianism is an ethical theory holding that the proper course of action is the one that maximizes the overall "happiness", by whatever means necessary. It is thus a form of consequentialism, meaning that the moral worth of an action is determined only by its resulting outcome, and that one can...

 and market theory further suppose that the outcomes for winners and losers can be identified, compared and measured.

Under these basic premises, the goal of maximizing allocative efficiency can be defined according to some neutral principle where some allocations are objectively better than others. For example, an economist might say that a change in policy increases allocative efficiency as long as those who benefit from the change (winners) gain more than the losers lose.

Conditions


It is possible to have Pareto efficiency
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...

 without allocative efficiency. By shifting resources in the economy, a gain in benefit to one individual could be greater than the loss in benefit to another individual (see Kaldor-Hicks efficiency
Kaldor-Hicks efficiency
Kaldor–Hicks efficiency, named for Nicholas Kaldor and John Hicks, also known as Kaldor–Hicks criterion, is a measure of economic efficiency that captures some of the intuitive appeal of Pareto efficiency, but has less stringent criteria and is hence applicable to more circumstances...

). Therefore, before such a shift, the market is not allocatively efficient, but might be Pareto efficient.

When a market fails to allocate resources efficiently, there is said to be market failure
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...

. Market failure may occur because of imperfect knowledge, differentiated goods, concentrated market power (e.g., monopoly or oligopoly), or externalities.

See also

  • Pareto efficiency
    Pareto efficiency
    Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...

  • Production-possibility frontier
  • Productive efficiency
    Productive efficiency
    Productive efficiency occurs when the economy is utilizing all of its resources efficiently, producing most output from least input. The concept is illustrated on a production possibility frontier where all points on the curve are points of maximum productive efficiency...

  • Financial market efficiency
    Financial market efficiency
    In the 1970s Eugene Fama defined an efficient financial market as "one in which prices always fully reflect available information”.The most common type of efficiency referred to in financial markets is the allocative efficiency, or the efficiency of allocating resources.This includes producing the...