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What is Economic Efficiency?

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  • Written By: Osmand Vitez
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  • Last Modified Date: 27 September 2016
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Economic efficiency is the study of how nations and businesses maximize the use of their economic resources or business inputs. Traditional economic resources found in the economic environment include land, labor and capital. Because nations and businesses are usually limited in these resources, they must find the most efficient way to produce the maximum amount of consumer goods without wasting resources. The inefficient use of economic resources in nations may lower the wealth of their citizens, while the inefficient use of resources can lead to companies spending too much capital producing goods or services.

Nations usually measure the efficient use of its economic resources by evaluating the livelihood or wealth of their citizens. A high quality of life or standard of living in a nation is a common indicator that a nation has maximized its economic efficiency by allowing the largest number of citizens access to economic resources. In a free market society, individuals are allowed to buy, sell or trade goods according to their own self interest. Efficiency will be achieved in the free market society when individuals cannot achieve greater wealth without decreasing the wealth of another citizen.

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In addition to the economic efficiency of a nation, businesses operating in the economic market also face efficiency challenges when producing consumer goods and services. The first way companies can achieve economic efficiency is by reaching the maximum production output of consumer goods or services without increasing the economic resources or inputs needed to produce the goods or services. All companies have a maximum production output with their current facilities or equipment; if companies cannot obtain more of these assets to increase production, they must find other ways to improve economic efficiency.

Another common method companies use when attempting to achieve economic efficiency is by producing consumer goods or services at the lowest cost possible. This type of efficiency focuses mainly on the efficient use of capital, rather than focusing only on the physical economic resources of land or labor. Management or cost accounting is a common tool companies use when tracking the economic efficiency of capital spent when producing goods or services. Management accounting traces all capital spent on economic resources and allocates the portion of business costs used to produce goods or services. This accounting method gives companies an accurate production cost so they can properly determine how much money has been spent on economic resources and how much money may need to be spent when purchasing more economic resources or business inputs.

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NathanG
Post 6

@nony - I believe in the free markets too, but they are not without their flaws. I think ideally we should have perfect competition, where every business gets an equal shot at success and no one can set prices for the market.

This is true in some industries but not in others. If you take computer software and operating systems, for example, Microsoft is still clearly a monopoly.

Legally, some of that monopoly status may have been broken up through a little litigation, but as a practical matter it still rules in the OS sphere, despite Linux and Mac OS nipping at its heels.

Is the Microsoft monopoly a bad thing? Well, since most of us have been accustomed to Microsoft software, maybe not, but it’s certainly not the best in what the free market has to offer from what I can tell.

nony
Post 5

It’s clear that economic efficiency for a nation is not a zero-sum game. I think the article makes that clear when it says that in order for one person to be wealthy, he doesn’t have to make another person less wealthy.

The problem of outsourcing may tend to make a lie out of that assertion, since outsourcing makes a lot of people less wealthy. However, I think people themselves can be very resourceful. It’s not uncommon in times of recession for example for people to choose to start their own businesses, becoming independently wealthy and self-supporting.

In this sense, the economy is efficient because it’s making the best use of its resources, and the businesses are also efficient even though they may have outsourced or taken some cost-cutting measures.

It’s a win-win, in my opinion. I’m a strong believer in the free markets.

turquoise
Post 4

@simrin-- As far as I know, that's mostly true.

Ideally, in a market, the greatest efficiency would be achieved if everyone got what they want or need the most. But that's only possible in an ideal world where everyone has an equal amount of money to spend. Then, everyone would spend as much as they want for whatever they need.

But that's not how it works, because people have different amounts of income and they're not always willing to pay the same amount of money for a good. So the most efficiency would be achieved for a firm when they are able to get the most money a consumer is willing to pay for the product with the lowest cost of production possible.

Hope this helped!

SteamLouis
Post 3

We are studying this in my economy course right now and I'm a little confused about something.

If a firm was selling a product and wanted to do this most efficiently, would efficiency here equal to the profit minus the cost of producing the product?

So if it costs the firm $5 dollars to make something, would selling the product for the highest price possible mean that this is the most efficient?

Can anyone explain?

ysmina
Post 2

I think sometimes, economic efficiency of businesses can actually negatively affect the economic efficiency of a country.

As American companies have been trying to improve their efficiency, they have been outsourcing more and more of their facilities to other countries where raw commodities and labor is cheaper. But as a result of this, many Americans have lost their jobs and have become unemployed. Some were not able to pay their mortgages, and lost their houses. Others could not find another job immediately and had to rely on unemployment benefits to take care of their families.

When companies do this, they do improve their efficiency and that might translate into lower prices for some products. But Americans can only buy if they have money, right? And many Americans have less money because of these companies' economic efficiency policies.

So am I wrong in saying that economic efficiency is not always good for a country?

sunshine31
Post 1

I know that the company that my husband works for recently moved their accounting operations to Costa Rica in efforts to increase the economic efficiency of the company. They felt that they could still hire very skilled accounting personnel for a third of the cost of an American employee.

The cost of doing business was also lower and judging by the presence of American companies in the area this seems to be a trend that many companies are following. Costa Rica also is a business friendly country with very low taxes and a stable political climate.

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