Efficiency vs Equity
Efficiency in production: labour, land, human capital
• Production function depicts the maximum output that can be produced from a given set
of inputs using currently available technology.
• Is it possible to get more output with the same inputs?
• Is it possible to get the same output with fewer inputs?
A production process is not technically efficient if answer to either of the question is ‘Yes’.
Cost- effectiveness efficiency: requires producing a good using the least cost method from
among all technically efficient methods.
- Takes relative prices into account. For instance, it is cost effective to produce a house
using labor intensive techniques is labor in that country is relatively cheap
PPF- shows the maximum combinations of two goods that society can produce given its
available resources and production technologies.
- All points on the production possibility frontier are technically efficient. However, points
inside the curve are technically inefficient.
- The PPF can be used to show the opportunity cost of production.
Efficiency in allocation
Allocative efficiency requires that society produce and distribute goods and services in accord
with the value that individuals place on those goods and services
- Identifying a resource distribution that is efficiently allocated requires knowledge about
individual’s preference over goods and services.
- An individual’s preferences regarding goods and services are summarized by his or her
utility function. The term ‘utility’ refers to the subjective satisfaction an individual
derives from consuming goods are services.
Grand Utility Possibility Frontier- the combinations of utility that everyone (or more than one
person) can attain given all feasible combinations of goods that can be produced.
• Pareto Criterion is used to decide the allocations that are allocatively efficient.
According to Pareto Criterion, an allocation is allocatively efficient if it is impossible to
reallocate resources in a way that makes at least one person