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Chapter 8

Chapter 8 (TEXT).pdf

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Department
Economics (Arts)
Course Code
ECON 208
Professor
Wendy Dickinson

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08_raga_ch08_topic_01.qxd 2/19/10 9:53 PM Page 1 EXPLAINING DIFFERENT CONCEPTS OF EFFICIENCY 1 Explaining Different Concepts of Efficiency In popular discussion, business decision making, and government policies, three differ- ent types of efficiency concepts are encountered. These are engineering, technical, and economic efficiency. Each is a valid concept, and each conveys useful information. However, the use of one concept in a situation in which another is appropriate i s a fre- quent source of error and confusion. Three Efficiency Concepts Engineering Efficiency Engineering efficiency refers to the physical amount of some single key input that is used in production. It is measured by the ratio of that input to output. For example, the engineering efficiency of an engine r ers to the ratio of the amount of energy in the fuel burned by the engine to the amount o f usable energy produced by the engine. The difference is in friction, heat loss, and other unavoidable sources of waste. Saying that a steam engine is 40 percent efficient means that 40 percent of the energy in the fuel that is burned in the boil converted into work that is done by the engine, while the other 60 percent is lost. N that engineer- ing efficiency is expressed in terms of the use of a single input and do es not involve financial considerations—it is purely about physical relationships. Technical Efficiency Technical efficiencyis related to the physical amount of all factors used in the process of producing some product. A particular meth d of producing a given level of output is technically efficient if there are no ot ys of producing the output that use less of at least one input while not using more of any hers. For exam- ple, consider a firm that is currently using 100 units of labour and nits of capital to produce a certain level of output. If the firm could maintain its current output level by using only 90 units of labourwithout using more capital,then it is being technically inef- ficient in its current methods because it is “wasting” 10 units of labour. Thus technical efficiency is about getting the most output from any given set of inputs; or, equivalently, about producing a given level of output using the least amount of physic l inputs. Note again that financial considerations are absent from this concept of e iency. Economic Efficiency Economic efficiency is related to the value (rather than the physical amounts) of all inputs used in producing a given output. The p oduction of a given output is economically efficient if there are no other ways of p ucing the out- put that use a smaller total value of inputs. For example, a firm may h e several alter- native production methods that it could use. One may require a lot of la our but only a little capital whereas another requires a lot of capital and only a littl r. A third production method may require a lot of land but relatively little of b labour and capital. In order to maximize its profits, the firm should choose the duction method that minimizes the costs for producing whatever level of output it choo s to produce. The firm would then be said to be economically efficient. Relationships Among Different Concepts What is the relationship between economic efficiency and these other two concepts? We have seen that engineering efficiency measures the efficiency with whi h a single Ragan and Lipsey, Economics,13th Canadian Edition Copyright © 2011 Pearson Canada Inc. 08_raga_ch08_topic_01.qxd 2/19/10 9:53 PM Page 2 2 EXPLAINING DIFFERENT CONCEPTS OF EFFICIENCY input is used. Although knowing the efficiency of any given gasoline, ele ctric, or diesel engine is interesting, increasing this efficiency is not necessarily economically efficient because doing so usually requires the use of other valuable resources. Fo r example, the engineering efficiency of a gas turbine engine can be increased by using more and stronger steel in its construction. Raising the engineering efficiency of an engine saves on fuel, but at the cost of using more of other inputs. To know whether this is worth doing, the firm must compare the value of the fuel saved with the value o f the other
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