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Efficiency drivers
Adrian Sims
Reviewing a few key areas of economics and the relationships between them could
gain you extra marks in the computer-based assessment and objective test papers
T
2 Perfectly competitive market
need to allocate scarce resources to
satisfy potentially unlimited wants.
£ Marginal cost
This situation of scarcity gives rise to the
need for an economic system to resolve
Average total cost
three fundamental questions:
l What should we produce, and how much?
l How should we produce it?
l Who should receive the output? Demand = average revenue = marginal revenue
Because resources are scarce relative to
the competing demands upon them, it’s in
society’s interests that they are used effi-
ciently. Economists distinguish between
two aspects of efficiency. Technical effi- QE Output
ciency takes its lead from the fundamental
economic question of “how?” It relates to
the amount of factors of production con- efficiency conditions, after the Italian econ- mechanism is one system for resolving the
sumed to make units of the product. omist and social theorist Vilfredo Pareto. economic problem. The price, cost and out-
Allocative efficiency picks up on the key Consider diagram 1: any point on the put solutions derived by different market
questions of “what?” and “who?” It concerns frontier – say A, B or C – is a point of techni- structures form a major part of the micro-
whether the system is making what people cal efficiency. Shifting from B to C means economics section of the syllabus. Let’s con-
want, and on what terms they can get it. society has more circuses but less bread. The sider them from an efficiency perspective.
Technical efficiency can be defined as the curve is steep here, denoting that society will Technical efficiency requires that the firm
point at which it’s impossible to make more sacrifice a lot of bread to get a few extra cir- produces at lowest average total cost – ie,
units of one product without foregoing units cuses. It reflects the fact that resources are where marginal cost equals the average total
of another product. Allocative efficiency can being transferred from making bread to pro- cost. Producing at lowest average total cost
be defined as the point at which it’s impossi- viding circuses, and that the productivity of means that the fewest resources possible are
ble to make one consumer better off without the transferred resources is falling – perhaps being used to make the level of output.
making another consumer worse off. These bakers don’t make good clowns. This is the Allocative efficiency requires that the
definitions are sometimes called the Pareto effect of the law of (eventually) diminishing price (sometimes called the average rev-
marginal returns. If this law didn’t apply, the enue) equals the marginal cost. This second
1 Production possibility frontier frontier would instead be the dotted diago- definition can be tough to understand, so
nal line on the diagram. let’s unpack it a bit. The key is to remember
A point inside the frontier – X, for example that economists analyse decisions in terms
A
Bread – is technically inefficient because, as the of opportunity costs. For the consumer, the
Y arrows show, the resources of the economy cost of buying one product is the satisfaction
could produce more bread and circuses using they forego by not having consumed their
the resources available. Point Y is unattain- next most preferred alternative. Say the
able within the present resource and techno- price of music CDs falls: as the consumer
B logical constraints of the economy. increases their consumption of CDs the
X The production possibility frontier can- added satisfaction they receive from having
not display allocative efficiency, though. It an extra CD in their collection declines – ie,
C
shows what combination of goods society the law of diminishing marginal utility
Circuses can make, but it doesn’t tell us whether applies. This predicts that they will demand
society wants them or not. The market more CDs up to the point at which the
Q is called excess capacity. Allocative ineffi- l If the private revenues are less than the government seeks to adjust private values
ciency occurs because the average revenue private costs, there will be an under- to reflect social values in five ways:
exceeds the marginal cost. It would need to production problem and the firm will l Raising private costs to equal social costs
produce at G to achieve allocative efficiency, make losses. through taxation. This discourages con-
but it still wouldn’t be technically efficient. l If the private costs are less than the social sumption of the product (eg, excise duty
So overall economic efficiency requires costs, the firm will overproduce. on cigarettes); production of harmful
the following condition to be satisfied: the On the production side, the private bene- products (eg, pollution taxes); or the use
average revenue equals the marginal cost fits to CIMA of your decision to take the of socially expensive processes (eg, taxes
equals the average total cost. But the costs qualification are the revenues it will bring in on commercial waste dumping).
and revenues expressed by this equation are from your student and exam fees, and your l Reducing private costs to encourage
private, conveying only the opportunity future spending as a member. But there are firms to make more socially desirable
costs and benefits to the consumer and the external social benefits too, such as the products that would otherwise be loss-
firm trading in the market. They overlook employer and branch networks CIMA sup- making (eg, subsidies to the arts).
externalities and therefore underestimate ports; the research it funds; and the contri- l Reducing the private costs of consuming
the social costs and benefits. bution to the development of management “merit goods” (eg, free health and educa-
Externalities are the costs and benefits accountancy resulting from the existence of tion provision; subsidies for public trans-
of a transaction that affects individuals a dedicated professional body. port; legal regulation of maximum
beyond the initial trading parties. Social If you decide not to qualify for CIMA, charges for personal pensions).
costs are the total welfare costs to society of your decision to underconsume will have a l Increasing the private costs of consuming
using resources in a given way. Social bene- knock-on effect that leads to the underpro- “demerit goods” (eg, traffic congestion
fits are the total welfare benefits from using duction of CIMA’s services. If the fees it charges or higher taxes for company cars
resources in a given way. charges do not cover its costs, the institute with high CO2 emissions).
The consumption decision can lead to will go out of business if left to a free market. l Increasing the private benefits of consum-
allocative inefficiency. If the private benefit In either event, the scarce resources of ing merit goods (eg, tax relief on charita-
is less than the social benefit, this will lead to CIMA would be dissipated and social wel- ble and pension contributions). n
an underconsumption of the product or fare would be reduced as the resources are
service. If the private benefit is greater than used for a less socially beneficial purpose. Adrian Sims teaches for BPP
the social benefit, this will lead to an over- To help correct the potential for market Professional Education in Luton
consumption of the product or service. failures as a result of externalities, the and Milton Keynes
Consider your decision to pursue the
CIMA qualification as an example.
l Private benefit: the increased income
that you or your employer (assuming that
it sponsors you) obtain from your
improved knowledge and skills.
l Externalities: your organisation gets a
more able employee; clients and sup-
Body building
pliers receive a better service; the share- The examiner for Organisational Management
holders’ investments will be better man- The subject of organisational development (OD) has featured in the intermediate
aged; and society may prosper from
getting a world-class business. level syllabus for years, but the questions in this field are rarely well answered
l Social benefit: your increased salary, plus
the externalities.
According to microeconomic theory, you
will pay for the CIMA qualification up to the
point where the marginal benefit per pound
spent equals that available from the next
best alternative. But suppose you calculate
that getting qualified would be too costly to
justify relative to the extra salary you’d gain. he term “organisational develop- and challenges – and the dizzying rate of
You would spend your money elsewhere and
therefore deprive society of all the positive
externalities. This would be an undercon-
T ment” (OD) dates back to the early
1960s, when Richard Beckhard and
Douglas McGregor used it to describe a
change itself ”. More recently, Cecil Bell and
Wendell French defined it as “a planned,
systematic process in which applied behav-
sumption market failure. consulting programme that focused on the ioural science principles and practices are
In the production decision, technical conflicting interests of organisations and introduced into ongoing organisations
inefficiencies occur as follows: their members. toward the goal of increasing individual and
l If the private revenues are less than the By 1969 Warren Bennis had defined OD organisational effectiveness”.
social benefits, the company will not as “a complex educational strategy intended Given the references to “change” and
generate enough of the product or service to change the beliefs, attitudes, values and “beliefs, attitudes and values” in these
to maximise social welfare – an under- structure of organisations so that they can definitions, it’s clear that OD has close links
production problem. better adapt to new technologies, markets with topics such as change management