There are two main standards of thought on economic efficiency, which respectively emphasize the
distortions created by
governments (and reduced by
decreasing government involvement) and the
distortions created by
markets (and reduced by
increasing government involvement). These are at times competing, at times complementary—either debating the
overall level of government involvement, or the effects of
specific government involvement. Broadly speaking, this dialog takes place in the context of
economic liberalism or
neoliberalism, though these terms are also used more narrowly to refer to particular views, especially advocating laissez faire. Further, there are differences in views on microeconomic versus macroeconomic efficiency, some advocating a greater role for government in one sphere or the other.
Allocative and productive efficiency A market can be said to have
allocative efficiency if the price of a product that the market is supplying is equal to the
marginal value consumers place on it, and equals
marginal cost. In other words, when every good or service is produced up to the point where one more unit provides a
marginal benefit to consumers less than the marginal cost of producing it. Because productive resources are
scarce, the resources must be allocated to various industries in just the right amounts, otherwise too much or too little output gets produced. When drawing diagrams for
businesses, allocative efficiency is satisfied if output is produced at the point where marginal cost is equal to average revenue. This is the case for the
long-run equilibrium of
perfect competition.
Productive efficiency occurs when units of goods are being supplied at the lowest possible
average total cost. When drawing diagrams for businesses, this condition is satisfied if the equilibrium is at the minimum point of the
average total cost curve. This is again the case for the long run equilibrium of perfect competition. For an extensive discussion of many other types of productive efficiency and its measures (Farrell, Hyperbolic, Directional, Cost, Revenue, Profit, Additive, etc.) and their relationships.
Mainstream views The mainstream view is that
market economies are generally believed to be closer to efficient than other known alternatives and that government involvement is necessary at the macroeconomic level (via
fiscal policy and
monetary policy) to counteract the
economic cycle – following
Keynesian economics. At the microeconomic level there is debate about how to achieve efficiency, with some advocating
laissez-faire, to remove government distortions, while others advocate regulation, to reduce
market failures and imperfections, particularly via internalizing
externalities. The
first fundamental welfare theorem provides some basis for the belief in efficiency of market economies, as it states that any perfectly competitive
market equilibrium is
Pareto efficient. The assumption of perfect competition means that this result is only valid in the absence of
market imperfections, which are significant in real markets. Furthermore, Pareto efficiency is a minimal notion of optimality and does not necessarily result in a socially desirable distribution of resources, as it makes no statement about equality or the overall well-being of a society.
Schools of thought Advocates of
limited government, in the form
laissez-faire (little or no government role in the economy) follow from the 19th century philosophical tradition
classical liberalism. They are particularly associated with the
mainstream economic schools of
classical economics (through the 1870s) and
neoclassical economics (from the 1870s onwards), and with the
heterodox Austrian school. Advocates of an expanded government role follow instead in alternative streams of progressivism; in the
Anglosphere (English-speaking countries, notably the United States, United Kingdom, Canada, Australia and New Zealand) this is associated with
institutional economics and, at the macroeconomic level, with
Keynesian economics. In Germany the guiding philosophy is
Ordoliberalism, in the
Freiburg School of economics.
Microeconomic reform Microeconomic reform is the implementation of policies that aim to reduce
economic distortions via
deregulation, and move toward economic efficiency. However, there is no clear theoretical basis for the belief that removing a
market distortion will always increase economic efficiency. The
theory of the second best states that if there is some unavoidable market distortion in one sector, a move toward greater market perfection in another sector may actually decrease efficiency. == Criteria ==