What is Productive Efficiency?

Productive efficiency, also referred to as production efficiency is a term in economics describing the level at which a company is operating at its maximum capacity. Beyond this point, the entity will be unable to manufacture any additional goods without cutting down another product’s production level. This occurrence is an outcome of production happening alongside a Production Possibility Frontier (PPF).

PPF / Production Possibility Curve

PPF is a curve that demonstrates the disparities in the amount produced of two goods if they both depended on the same limited resources to manufacture. It is used for business analysis, PPF has a significant role to play in economics. It illustrates the point of maximum efficiency, where an entity can produce to its fullest capacity. Hence, at this point, a nation produces what it is best equipped to produce and imports the rest from other nations. The PPF curve is also called a transformation curve or production possibility curve.

What is Allocative Efficiency?

Allocative Efficiency is a particular combination of products or services that are produced by society and it corresponds to the combination most desired by the society. For example, a society with young consumers will prefer education over health care. Hence if the production of education equals the demand, then the society has achieved Allocative efficiency. However, what is desired by a society is a contentious subject and forms a vital discussion point in sociology, political science, economics, and philosophy. At a very base level, allocative efficiency means production or supply of desired goods or services that meet consumer demand. Only one desired option will achieve allocative efficiency for society.

PPF and Comparative Advantage

Every society is faced with the question of how much of each product should it produce? The society or nation does not need to produce all products that it consumes; how much it chooses to produce is dependent on whether it is cheaper to make it in the home nation or buy from another country. As discussed earlier, the PPF or the transformation curve of a country shows the variations of allocating resources to produce one good versus another. The curve shows the difference in the opportunity cost of units of a good produced on the X-axis as compared to units of another good produced on the Y-axis. The opportunity cost of production of one country can differ from another country due to differences in skills, technology, geography, or climate.

Importance of Productive Efficiency

Production efficiency stands for maximized output using a finite set of resources. It is not only a measure of productivity levels but efficiency also measures the resources needed for production. This helps an organization minimize costs and maximize resources without compromising on the quality of goods.

Importance of Allocative Efficiency

At a level where allocative efficiency is achieved, the marginal cost is closest to marginal benefits. Simply put it means that the cost of a good or service and the marginal benefit a consumer gets out of using the product is as close as possible. Allocative efficiency happens when all market participants have access to market data to make informed decisions regarding what to produce or purchase and in what quantities.

Productive Efficiency and Allocative Efficiency – A comparison

Productive and allocative efficiency both compare how efficiently the demands are met with output. The difference between them is that they describe different aspects of production. Productive efficiency determines whether a company has the right production functions in place to maximize the production of good quality products by optimizing costs. While allocative efficiency determines if there is the correct quantity produced to meet the demand.

 Productive Efficiency – Calculation

To calculate productive efficiency, the actual output rate is compared to the standard output rate. For example, to measure the productive efficiency of an employee, the completion rate of the worker is compared to the standard completion rate. The standard completion rate is the work that can be performed per unit of time. This data is collected from past data and through the time study process.  A time study sets a standard or a baseline to control and manage performance.

Example

An office with a wall area measuring 100 sq mt has to be repapered.

Production efficiency = Actual output rate divided by Standard output rate, multiplied by 100

If the standard rate to repaper 100 sq mt is 24 hours, but the workers took a total of 30 hours to finish the job, production efficiency can be calculated as –

Actual output rate: $\text{100 sq mt / 30 hours = 3}\text{.33 sq mt per hour}$

Standard output rate: $\text{100 sq mt / 24 = 4}\text{.16 sq mt per hour}$

So, production efficiency = $\left(3.33/4.16\right)\times 100=80.04\%$

How can Productive Efficiency be increased?

To enhance productivity or production efficiency, it is essential to have access to baseline data from reliable sources. If employees in managerial positions know the current level of efficiency, it becomes easier to identify any function that needs improvement to cash in on opportunities. Post this step, the company is in a better position to measure the process improvement effects. Some ways to increase production efficiency are -

Efficient Workflows

A workflow defines the steps of functions or procedures that are set as established standards. Sometimes it is not the procedural steps but the skill sets or technical know-how of the team that helps enhance workflows. Efforts should be taken to simple steps to make workflow efficient.

Employee Training

Nothing works as much as knowledge to rid a company of inefficiencies. Training and developing the skill-sets of an employee is a continuous process and adds value back to the system.

Preventive Maintenance Process

A preventive maintenance process ensures that a team can effectively plan out resources in good time to eliminate untoward surprises that can result in a setback.

Organizing

An organized and planned approach cuts down unnecessary work and steps. This helps with the effective allocation of time to things that require it.

Summarization for Productive and Allocation Analysis

Monopoly – A single seller who does not have to face competitive markets as he is the sole seller of a unique product in the market is called a monopoly. The seller faces negligible competition in a monopoly market with no substitutes for the product.

Marginal Cost – Marginal cost is the incremental cost incurred to produce additional units of a product or service. To calculate marginal cost, change in the cost to produce additional products is divided by the change in the number of products manufactured

Economic efficiency – In an economy, when all scarce resource is utilized and distributed between producers and consumers, to achieve the most economic output and to generate benefit for the consumer is known as economic efficiency. Economic efficiency involves efficient production decisions taken by a firm, efficient consumption decisions taken by the consumer, and efficient distribution of scarce resources among firms and consumers.

Pareto Efficiency – Pareto efficiency is when all economic goods are allocated to the optimum efficiency level across production and consumption. Beyond this point, any change made to the arrangement can improve the situation for someone but at the cost of someone else.

 Common Mistake

Allocation efficiency can only happen when resources are allocated correctly as per the needs and wants of a consumer. For an error-free evaluation of allocation efficiency, free access to market data is of prime importance. Asymmetrical information will not help in making the most efficient decisions regarding production and consumption.

 Context and Applications

This topic is relevant in the professional exams for undergraduate and graduate courses –

• BA Economics
• BA Economics Honors
• MA Economics
• Master of Finance
• Master of Business Analytics
• MBA

Related Concepts

• Behavioral Economics
• Circular Economy
• Economic Policy
• Globalization
• International Trade
• Macroeconomics