Allocative efficiency is the degree to which the marginal benefits consumers receive from goods are as close as possible to the marginal costs of producing them. At the optimal level of allocative efficiency in a given market, the last unit's marginal cost would be perfectly equal to the marginal benefit it provides consumers, resulting in no deadweight loss.
The amount of value generated in a market that efficient equals the social value of the produced output minus the value of resources used in production. Optimal efficiency is higher in free markets, though reality always has some limitations and imperfections to detract from completely perfect allocative efficiency. Markets are not efficient if it is subject to:
Final goods
When an economy has allocative efficiency, it produces goods and services that have the highest demand and that society finds most desirable. For example, for the U.S. to achieve an allocative efficient market, it would need to produce a lot of coffee.
- monopolies,
- monopsonies,
- externalities,
- public goods which construe market failure, or
- price controls which construe government failure in addition to taxation.
Allocative efficiency is the main means to measure the degree markets and public policy improve or harm society or other specific subgroups.
Although there are different standards of evaluation for the concept of allocative efficiency, the basic principle asserts that in any economic system, choices in resource allocation produce both "winners" and "losers" relative to the choice being evaluated. The principles of rational choice, individual maximization, utilitarianism, and market theory further suppose that the outcomes for winners and losers can be identified, compared, and measured.
Under these basic premises, the goal of maximizing allocative efficiency can be defined according to some neutral principle where some allocations are objectively better than others. For example, an economist might say that a change in policy increases allocative efficiency as long as those who benefit from the change (winners) gain more than the losers lose.