Is Allocative Efficiency and Social Efficiency the Same?

Allocative efficiency

It is when scarce resources are being combined in such a way to produce the highest number of output using the least cost method and these products are actually what the consumers desire the most as reflected by the value they place on it. Therefore, this relationship can also be written as P = MC or MB = MC or AR = MC (P = AR = MB)

Social efficiency

The condition for social efficiency is stricter and harder to be achieved. It is when scarce resources are combined in such a way to produce the maximum number of output using the cheapest possible method of production and these goods are what people value the most, taking into account both negative and positive externalities. The condition for social efficiency is when MSB = MSC

Relating all together

As can be seen, allocative efficiency may or may not be the same as social efficiency, depending on the case studies that we use. In practice, as observed, they are unlikely to be the same. In fact it is quite impossible for the relationship between the two to be identical

To simplify our analysis, consider merit goods like alcohol and cigarettes. A firm is said to be productively efficient if these cigarettes are produced using the most cost efficient method. In other words, the company itself is operating where MC = AC

The same firm can also become allocatively efficient if the cigarettes that they manufacture are actually what the smokers desire the most as reflected by the price that they are willing and able to pay. Therefore the condition of P = MC is met

However, cigarettes are demerit goods and smoking is always associated with negative externalities. In a pure market economy, firms will only take into account their own PB and PC during the production process. Therefore, cigarettes are manufactured up to the point where MPB = MPC. The same can be said with consumers. As they smoke, they only consider their own MPB and MPC and so will smoke up to the point where MPB = MPC. However, from the society’s point of view, smoking is harmful and its production or consumption should be reduced up to the point where MSB = MSC. The overproduction and overconsumption of cigarettes have resulted in the case of market failure

In conclusion, even if a firm is both productively and allocatively efficient, it is not necessarily socially efficient. Yes, they produce goods and services that consumers value the most and therefore in theory, allocation of resources should be efficient. However, the firm does not meet the last condition. Not everyone concurs that cigarettes are ‘beneficial’ and in most cases, societies (majority of the population which is non-smoker) often object their existence. Therefore, allocatively efficient and socially efficient are not the same

Can An Economy Achieve Both Productive Efficiency and Allocative Efficiency Simultaneously?

A nation may or may not achieve productive efficiency and allocative efficiency simultaneously. Why is that the case?

Economic efficiency

Efficiency is achieved if scarce resources are successfully combined in such a way, to produce only those products that are highly valued at the greatest amount using the least cost method. The idea of efficiency can be further divided into two and they are productive efficiency and allocative efficiency

Productive efficiency

This concept can be viewed from both microeconomic and macroeconomic perspectives. In the former, we always say that a firm is being productively efficient if it is able to produce at the level of output where AC is at its lowest. Mathematically, we can also write this as MC = AC. Why is that so? The answer is very simple. The MC curve will always cut the AC curve from its minimum and hence the relationship is established in such a way

From macroeconomic angle, we can actually use the PPC to reflect the idea of productive efficiency. A nation is said to be productively efficient if it is already operating along the boundary of its PPC. There are no wastages in the economy e.g. unemployment and idle machinery and all resources have been fully and efficiently utilised. By stretching the usage of all resources to the their potential, a country will be able to land on its frontier

Allocative efficiency

Again, in the same way, we can view the concept of allocative efficiency via both microeconomic and macroeconomic angles. The former can be attained if a firm operates at the level of output where P = MC. It is worth nothing the identity of P = MB = MU. In fact, they are all the same. Why? The price that consumers place on a product is actually the benefit or the satisfaction that they think they can get from using it. If a customer values the consumption of a particular output, he or she will be prepared to pay a price that justifies their preference. Would you be willing to pay MYR 2,000,000 for a second-hand car? You know the answer. But, if I change the subject to Lamborghini Aventador 6.5, then you would most likely say yes and perhaps willing to pay more (if you can afford to do so) because the market price of this car in Malaysia is around MYR 2.8 million. You are willing to pay such a high price because you feel that the benefits worth that much. That is why, a product is allocative efficient if P = MC or MB = MC. The price that people are willing and able to pay reflects the costs of producing it

From macroeconomic angle, allocative efficiency is attained if an economy is operating along the boundary of its PPC. Resources have been combined in such a way to produce the highest level of output which is valued by the consumers

Achieve both simultaneously

An economy is able to become both productively and allocatively efficient upon the condition that resources have been gathered to produce the maximum number of output using the least cost method where all the products are actually what the people want. Interestingly, all the points on the PPC are productively efficient. However, there can only be one point which can be regarded as allocatively efficient. It represents the combination of two goods which is most optimal/ preferred

Not possible to achieve both simultaneously

It is also possible that an economy can actually achieve one without the other. Think about North Korea. Think about the famous famine which took place somewhere between 1994 and 1998. It was a period that no one can ever forget. Millions of North Koreans died of hunger. The communist/ socialist government under the leadership of Kim Jong-Il particularly operated by the principle of ‘Songun’ or more commonly known as military-first policy. This seems to be somewhat antithesis because in a command economy, it should be people’s interest that comes first. What happen was, the military sector continued to get more attention e.g. weapons and nuclear technology. The economy as a whole may be productively efficient but definitely not allocative efficient. Scarce resources are not devoted towards what the people wanted and value the most-food products, healthcare, education and other modern infrastructure

Business, Bankruptcy and the Concept of Efficiency

“The company once stood at the top of the smartphone market. Its smartphones were carried by mobile professionals in the tens of millions. Former BlackBerry co-CEO Mike Lazaridis scoffed at the original iPhone. He thought it was a toy. He derided its poor battery life and balked at the idea that anyone would want to type on glass when BlackBerrys offered full QWERTY keyboards. The original iPhone may not be impressive by today's standards, but there's no denying that it forever altered the smartphone paradigm. It offered a big screen, a capable browser and the best music/video experiences available from a mobile device, something that BlackBerrys (and most other smartphones at the time) did not. As the saying goes, BlackBerry didn't adapt -- at least, not fast enough -- to the changes in the market. Classic Darwinism in action. (Nokia is guilty of this too.)

BlackBerry's leadership probably thought it was responding to the Apple iPad in a timely manner, getting a competitive product to market as quickly as it could. It did this at the expense of its smartphones. BlackBerry pulled resources away from its smartphone development teams in the months leading up to the PlayBook's debut. Instead, it should have skipped the tablet altogether and focused on its core smartphone business, which was already in trouble. (Handset sales historically are responsible for 80% of BlackBerry's revenue.)”

Source: http://www.informationweek.com/mobile/mobile-devices/blackberrys-collapse-5-key-mistakes/d/d-id/1111195?

Analysis of the case study:

What is Economic Efficiency?

Economic efficiency is attained when scarce economic resources are combined in such a way to produce the highest number of output yet at the lowest cost which fulfills as many wants and needs as possible

BlackBerry and Productive Efficiency

Productive efficiency is achieved when a firm is able to produce the highest level of output using the least cost method of production. The first condition is related to technical efficiency and can only be achieved if the most productive set of inputs is chosen. The second part refers to cost efficiency. If it is possible, a firm would like to use or hire the cheapest set of factors of production which also happens to be the most productive. If these two conditions are met, then a firm would be able to operate at the level of output where MC = AC. It is written in such a way because MC (marginal cost) curve cuts AC (average cost) curve at its lowest

 

BlackBerry operates under the condition of imperfect market. Based on the information gathered, it suggests that BlackBerry was previously the market leader or better known as the monopoly in the smart phone market. However, the existence of substantial abnormal/ supernormal profits in the industry has somehow encouraged more new firms to join the industry. Two big names are Apple and Samsung. It did not take long for BlackBerry to move down the ladder to become an oligopoly then. In theory, a monopoly or an oligopoly firm will not be productive efficient. Absence of competition and the ability to engage in price fixing do not give large firms any incentive to cut costs to raise their abnormal profits. High operational costs and yet falling sales explain why BlackBerry’s margin gets thinner all time

BlackBerry and Allocative Efficiency

Allocative efficiency is achieved when a firm successfully combines all the scarce economic resources to produce goods and services that match consumer preferences. When this happens, P (price) = MC (marginal cost). It is also worth noting that P = MB (marginal benefit) = MU (marginal utility). What is meant by P = MB then? This is quite simple. The price that we are willing and able to pay for a particular output is reflected by the benefits that we get from its consumption. If we think that the private benefits are tremendous, we will place a high price for it. Likewise, if the private benefits are low, then the price paid must also fall. As an example, a rationale person will not pay $1 million dollar to own an ordinary second-hand car. However, this may not be the case with Rolls-Royce

 

In the case of BlackBerry, it is not being allocative efficient. It is likely to be operating at the level of output where MB < MC. Consumers in general no longer value the smart phones as much as the costs used up to produce them. As long as buyers feel that it is not worthwhile to own one at such a price, they will start to look for alternatives, causing market share and sales to shrink. It is said that BlackBerry initially refused to listen to customer complaints, refused to give consumers the design and functions that they badly want and refuse to move on in a dynamic market

It thought that its monopoly position could be safely secured making and as such there wasn’t any need to innovate and conduct R&D. Samsung and Apple on contrast, listen to the consumers. They gave the people what they want, making every dollar that is being paid for worthwhile. This is why the two of them thrive

Overall inefficiency

The article also suggests that BlackBerry pulled away its resources from smartphone development teams to fully concentrate on the PlayBook to compete against IPad. However, it seemed to forget that the main contributor to its revenue was smart phone segement. This means resources are not allocated in the most efficient way to meet its corporate agenda