Productive Efficiency
What is Productive Efficiency?
Productive efficiency is an economic state where a firm produces a given level of output at the lowest possible cost.
Productive efficiency occurs when a firm is using the least amount of inputs (resources) to produce the maximum amount of output. This is achieved when a firm is producing at the minimum point of its average total cost curve. Productive efficiency is one of the conditions under which markets are considered economically efficient.
Productive Efficiency: a worked example
A bakery's total cost at 200 loaves is $600, so average total cost is 600 / 200 = $3.00 per loaf. At 300 loaves total cost is $840, giving 840 / 300 = $2.80 per loaf. At 400 loaves total cost is $1,240, giving 1,240 / 400 = $3.10 per loaf. The lowest cost per loaf in this range is $2.80 at 300 loaves, so 300 is the productively efficient output. Watch the trap in the numbers: total cost is smallest at 200 loaves, but productive efficiency compares cost per unit, not the size of the total bill.
The mistake students make with productive efficiency
The tempting mistake is hunting for the lowest total cost. Total cost is always lowest at zero output, which is not efficiency, it is shutting down. Productive efficiency means the lowest cost per unit, the minimum of average total cost, which is also the point where the marginal cost curve cuts ATC from below. A second slip is assuming a productively efficient firm must be making the right product. Producing buggy whips at the lowest possible cost per whip is productively efficient and still a waste of society's resources.
Productive Efficiency questions
Where is productive efficiency on a production possibilities curve?
Productive efficiency on a production possibilities curve covers every point on the curve itself, not one special spot. Any point on the frontier uses all available resources with the best current technology, so more of one good can only come by giving up some of the other. Points inside the curve are productively inefficient, usually from idle resources or workers badly matched to jobs. Which point on the curve is best is an allocative question, not a productive one.
Does perfect competition achieve productive efficiency?
Perfect competition reaches productive efficiency in long run equilibrium, once free entry has pushed price down to the minimum of average total cost. Each firm then produces at the bottom of its ATC curve and earns zero economic profit. In the short run a competitive firm can sit away from that minimum, and a monopolistically competitive firm never reaches it, because its long run output settles where demand is tangent to ATC on the downward sloping part.
Can a firm be productively efficient and still lose money?
A firm can be productively efficient and still lose money, since minimum average total cost says nothing about what buyers are willing to pay. If a firm's lowest achievable ATC is $2.80 per unit and the market price is $2.40, it is producing as cheaply as it possibly can and still losing $2.80 - $2.40 = $0.40 on every unit. Efficiency describes the cost side; profit needs the revenue side to cooperate as well.
This is the live Production Possibilities sandbox. Drag the curves, or open the full version.
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