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What is Allocative Efficiency?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 09 December 2016
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Allocative efficiency has to do with the degree in which a given action leads to the production of more positive results than the creation of negative results. This basic approach to measuring benefit derived comes into play with many different types of business functions, including the creation of a client base, the organization of a business entity, and the ultimate success or failure of that entity. In short, allocative efficiency is all about generation substantial benefits while producing relatively few liabilities.

To understand how the concept of allocative efficiency works, consider the decision of a company to make a procedural change in the way that information is shared throughout the organization. Instead of making use of hard copy documents as the primary means of relaying data, the decision is made to create an in-house network where reports and other data is distributed using email and a private messaging program. This change immediately produces benefits in the form of a decrease in the cost of office supplies that are normally used to create hard copy documents, while also increasing the speed with which information is shared between department heads and within individual departments.

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At the same time, there is likely to be some amount of negative reaction to the new process of communication. Those who prefer paper documents are likely to be less responsive, which could slow down the efficient use of the data. Others may feel intimidated by the new system, and be hesitant to make full use of the resources. The concept of allocative efficiency demands that the company weigh the benefits of implementing this electronic communication strategy with the possible disadvantages. If it is decided that the benefits substantially outweigh any liabilities and will move the company forward, the allocative efficiency demands that the changes be made.

By the same token, a state of allocative inefficiency can be achieved if actions are taken without due consideration to the possible advantages and disadvantages that are likely to develop. This is true regardless of whether the benefits are highlighted while disregarding the possible liabilities, or accentuating the disadvantages while not looking closely at the possible advantages that the action will produce. In order to avoid this type of slanted projection, it is important to consider both factors and thus create the balance that is inherent in allocative efficiency.

The general approach can be utilized in just about any type of business setting. Small business owners may consider how carrying a certain brand of goods will impact the profits of the enterprise. Department managers in large corporations may investigate the positive and negative outcomes that are likely to occur by restructuring the departmental workforce. Even in situations where changes to a board of directors become necessary, applying the idea of allocative efficiency can help shareholders refrain from placing the wrong person on the board for several years.

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SarahGen
Post 3

Allocative efficiency can also refer to how resources and production are allocated in a national market.

A great example is the Soviet Union. In the Soviet Union, allocative efficiency was poor. There were many factories producing things like weapons whereas fewer factories produced food items and clothes. It was inefficient because companies were not producing what people needed, they were producing goods that did not have much demand. This is a loss of resources and profit.

In an economy, there should be some diversification. Different companies should produce different things and all production should be driven by consumer demand. Free markets are allocatively efficient because supply naturally depends on demand. A free market regulates itself.

SteamLouis
Post 2

@burcinc-- Productive efficiency is making the most goods at the lowest cost. I think it's found by dividing expenses by revenue. If efficiency is over 100%, it means that the company has very poor efficiency and is experiencing losses.

Allocative efficiency is more about lowering costs and allocating resources for greater efficiency in a company. So the two terms are similar. Productive efficiency is the basic cost-profit measurement tool and allocative efficiency is about allocating resources differently.

burcinc
Post 1

Does anyone know about allocative efficiency vs productive efficiency? What is the difference? I need to learn about this before economics class next week.

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