Allocative Efficiency is a market situation in which a business or firm produces the right goods for the right people in the right amounts at the right price. Allocative efficiency is when the price of production equals the marginal cost (P=MC). It requires that an economy produces the right mix of goods and services with each item being produced at the lowest possible unit cost. Using limited resources, it employs all possible opportunitites to the full potential. Essentially, an allocatively efficient market system is one that is perfect.

For example, in a particular business, the 2 products being produced are pizza and robots. As the quantity of pizza goes up, the quantity of robots must go down. This situation illustrates allocative efficiency because at every point, every possible resource and worker are being used. In a production possibilities curve (PPC), each of these points would lie on the frontier, meaning that each of these production possibilites is both attainable and efficient. In this situation, however, points A and E would not be considered allocatively efficient because there would be no mix of goods.

Type of Product
A
B
C
D
E
Pizzas (in hundred thousands)
0
1
2
3
4
Robots (in thousands)
10
9
7
4
0

Sample Question:
Let's say that a company wants to produce a new type of car. They decide that because this care is going to be so great that they will not need to sell any other type of car. The company introduces the new model and is an instant success, bringing in millions of dollars for the company. Is this situation allocatively efficient?


external image Fig%208.14%20Allocative%20Efficiency.jpg

The video gives a general overview of some important topics in microeconomics including the overproduction and underproduction in market systems, which are the determining factors in allocative efficiency.


The answer to the sample problem is no, this market is not allocatively efficient because the car company does not have a mix of goods.


http://vlad1mir.tripod.com/allocative_efficiency_in_a_perfectly_competitive_market.htm

http://ideas.repec.org/p/diw/diwwpp/dp591.html

http://en.wikipedia.org/wiki/Allocative_efficiency