Allocative Efficiency

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When we are right on the PPF curve, i.e., we are producing at allocative efficiency, then it signifies that in order to manufacture more of one commodities then it is necessary to give up some other good. Even if one good produces greater benefit than the other, we cannot manufacture more of it without giving up certain other commodities that provides even better benefits.

Letโ€™s understand it better with an example. Say if the marginal cost of one pizza is three cola cans and its marginal benefit is four cans then resources can be reallocated to produce more pizza and less quantity of cola cans. This will provide better benefit as a person will value an additional pizza higher than its production cost.

Now suppose the quantity of pizza available rises. Now a person will value an additional unit of pizza less and when the marginal cost falls below the marginal benefit, it means a person is willing to pay less than the production cost for an additional unit. This leads to the scenario where greater benefit can be generated by producing more cola cans and fewer pizzas.

The resource allocation between the goods is considered to be most efficient when the marginal benefit andmarginal cost of a good is same. For example if the marginal cost and benefit of 2 million pizza units is 3 cola cans, then the worth of additional pizza units produced will be less than the cola cans forgone and if more cola cans are produced then the worth of an additional cola can will be less than the worth of an additional pizza unit forgone.


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