Allocative Efficiency, Comparative advantage and Free markets introduction
There are two main concepts that describe the allocation of resources.
Allocative Efficiency: This looks at how the production can be used to make one person
better off without damaging the other person. This thinks about producing the right things
using the economy
“ A situation in which production can be reallocated to make at least one person
better off while making no one else worse off.”
When demonstrating this with the production possibility boundary there can only be one
point which is allocatively efficient.
Technical Efficiency: It is also known as productive efficiency. This is when one good is
produced and automatically the production of other good is reduced. It is impossible to
produce relative amount of both goods.
“A situation in which it is impossible to produce more of one good without
simultaneously producing less of another.”
- When using old technology or unused resources it leads to technical inefficiency.
Points on the production possibility boundary are technically efficient. Technical
efficiency thinks about is economy producing as much as possible.
Comparative Advantage:
The questions why is it that people trade? What is the purpose of it?
Trading can be between two individuals or two countries.
For example, Einstein, he was good at physics and let’s assume that he was also good at
typing. So, should he type his own work or hire someone else to do it for him? Comparative
advantage and opportunity cost of capital are linked in some way. According to the concept
of opportunity cost of capital if Einstein types then the opportunity cost of it would be
missing out the physics work. To choose between the two desires (Typing & Physics) he
would need to consider what is he best at, where he has an advantage. He was better at
Physics than typing, he has an advantage at physics in comparison to typing. This is the
concept of Comparative Advantage. All trading decisions are based on comparative
advantage.
For example;
Whole week Whole week Time divided Specialising in
used to used to equally area of
produce produce comparative
advantage
Sweaters Suits Sweaters Suits Sweaters Suits
Alice 100 20 50 10 75 5
Bob 24 12 12 6 0 12
There are two main concepts that describe the allocation of resources.
Allocative Efficiency: This looks at how the production can be used to make one person
better off without damaging the other person. This thinks about producing the right things
using the economy
“ A situation in which production can be reallocated to make at least one person
better off while making no one else worse off.”
When demonstrating this with the production possibility boundary there can only be one
point which is allocatively efficient.
Technical Efficiency: It is also known as productive efficiency. This is when one good is
produced and automatically the production of other good is reduced. It is impossible to
produce relative amount of both goods.
“A situation in which it is impossible to produce more of one good without
simultaneously producing less of another.”
- When using old technology or unused resources it leads to technical inefficiency.
Points on the production possibility boundary are technically efficient. Technical
efficiency thinks about is economy producing as much as possible.
Comparative Advantage:
The questions why is it that people trade? What is the purpose of it?
Trading can be between two individuals or two countries.
For example, Einstein, he was good at physics and let’s assume that he was also good at
typing. So, should he type his own work or hire someone else to do it for him? Comparative
advantage and opportunity cost of capital are linked in some way. According to the concept
of opportunity cost of capital if Einstein types then the opportunity cost of it would be
missing out the physics work. To choose between the two desires (Typing & Physics) he
would need to consider what is he best at, where he has an advantage. He was better at
Physics than typing, he has an advantage at physics in comparison to typing. This is the
concept of Comparative Advantage. All trading decisions are based on comparative
advantage.
For example;
Whole week Whole week Time divided Specialising in
used to used to equally area of
produce produce comparative
advantage
Sweaters Suits Sweaters Suits Sweaters Suits
Alice 100 20 50 10 75 5
Bob 24 12 12 6 0 12
