Economic efficiency is defined in a variety of ways. Most simply stated, efficiency is the lack of waste. Economic efficiency in production is using the method that requires the least amount of resources to produce a given level of output. Efficiency is also associated with producing at the lowest point on a firm’s average total-cost curve, producing at the least cost per unit possible.
Economic efficiency is also defined as a situation in which any reallocation of resources cannot make one person better off without harming someone else. This is known as Pareto Optimality, named after the Italian economist Vilfredo Pareto. Optimality is a bit misleading in that it usually infers the “best” outcome possible, whereas in reality many economic situations present multiple outcomes that are nearly equally efficient.
Economists also use a PRODUCTION POSSIBILITIES CURVE (PPC) to portray efficiency for an economic system. A country or business is said to have achieved economic efficiency when it has produced any combination of output that maximizes their production capability with existing RESOURCES and technology. Economic growth is portrayed by a rightward shift of the PPC through expansion of the quantity of resources, improvements in technology, or improvement in the quality of resources.
The 18th-century Scottish philosopher Adam Smith is credited with first describing economic efficiency of markets. In his famous “invisible hand” analogy, Smith suggested that self-interested individuals, both sellers and buyers, act as if driven by an invisible hand to produce economic efficiency. Buyers will attempt to maximize their benefits from the scarce resources they own. Sellers will attempt to maximize their return from the products they produce and sell. In the process, sellers and buyers will reduce and eliminate waste, producing what is most desired in the marketplace and purchasing those goods that maximize utility.
Advocates of LAISSEZ-FAIRE economic theory argue that economic efficiency is maximized when markets are allowed to act freely without government control or intervention. Critics counter that economic efficiency depends on having competition, and the assumed goal of businesses, maximizing PROFITS, is best achieved by reducing competition. Therefore government is needed to ensure markets operate as competitively as possible in order to achieve economic efficiency.