Allocative Efficiency

Allocative Efficiency

What is Allocative Efficiency?

Definition

Allocative efficiency is a term used in economics that refers to a situation where the available resources are used in a manner that produces the greatest level of benefit.

What does allocative efficiency mean?

To understand the term “allocative efficiency,” it is important to first get to know the meaning of “marginal cost” and “marginal benefit.” Marginal cost refers to the opportunity cost or the loss of other alternatives when producing an additional unit of a certain good or service. Marginal benefit is the additional satisfaction or enjoyment that is obtained from consuming one more unit of a good or service. Now that we understand what marginal cost and marginal benefit mean, it will be simpler to understand the term allocative efficiency. Allocative efficiency is the point at which the marginal cost of a product or service is equal to the marginal benefit that it provides. When this happens, it indicates that there is an optimal utilization of resources. In other words, allocative efficiency is said to occur when the price that a consumer is willing to pay for a good or a service is exactly equal to the benefit that it provides. What are the conditions that are necessary to bring about a state of allocative efficiency? Firstly, information and data must be freely available to both producers and consumers. This will allow resources to be allocated in the most efficient manner. Additionally, consumers should be able to choose the products and services that provide them with the greatest level of satisfaction.

Example of allocative efficiency

Imagine a poor country in Asia or Africa that has a large population of school-age children. There are also a significant number of older people who require health care and medical facilities. The government has limited resources. There isn’t enough money to build the required number of schools and as well as the hospitals that are required. What should be done to maximize the benefits that are available to the country’s citizens? The government has to find the point of allocative efficiency between schools and hospitals. It has to use its limited resources in a manner that provides education and medical facilities to the maximum possible number of its citizens.

Summary

When there is allocative efficiency in a society, its resources are used in a manner that provides an optimal level of benefit to all parties. The price that a consumer pays for a good or service is equal to the benefit that this good or service provides.