"Here’s what looks like a policy dilemma. To attain the economic growth that it desperately needs, the United States must improve its schools and train a workforce capable of competing in the global economy. Economists Eric Hanushek, Dean Jamison, Eliot Jamison, and Ludger Woessmann estimate that improving student achievement by half of one standard deviation—roughly the current difference...
Economic Efficiency: Making the Most of Our Resources
Efficiency is a word that is thrown around a lot these days. Many businesses are trying to be more efficient with their resources. Many individuals are trying to be more efficient with their time. In other words, they want more output for their input of a limited resource. That resource may be money, energy, or even hours. In a world with limited resources (scarcity), economic efficiency is an important goal. It is also a difficult, if not impossible, thing to measure because it is subjective.
Economists often define "Economic Efficiency" as using a resource for its highest value. Value is usually determined by the dollar amount paid for a resource. However, sometimes what may be an efficient use of limited resources for one person may be an inefficient use for another.
History shows that at the micro level, efficiency is something that can be measured if inputs, outputs, values, and goals are well defined. At the macro level, efficiency is difficult, if not impossible, to measure simply because, as good as economists' equations are, there are still too many unknown variables to measure, and value remains subjective.
Many factors contribute to economic efficiency. One important tool that multiplies production capacity is the division of labor. In his economic treatise, the Wealth of Nations, Adam Smith famously illustrated how several men performing different steps of pin-making would be able to make substantially more pins apiece than if they each had been completing the entire process on their own.
The same is true for trade. When individuals or countries specialize in one type of work, especially if it reflects their comparative advantage (what they do best), they will be better off by trading their products with other people or other nations. On the flip side, countries with barriers to trade often protect inefficient businesses. Because they lack outside competition, protected firms do not have the incentive to improve efficiency in order to survive.
Despite our inability to measure economic efficiency broadly, the beauty of a market economy is that it tends to allocate resources to their most efficient, highest valued use, even without one person knowing all the facts. Adam Smith's "Invisible Hand" is an apt description of this market process. The invisible hand uses triggers like prices to indicate what people value most (demand) and then incentivizes producers to use resources toward those preferred uses (supply).
In The Use of Knowledge in Society, economist F.A. Hayek investigates whether this market-driven, competitive system, or a system of central planning is more efficient in using available knowledge to allocate resources. He finds the price system to be more economical because it communicates crucial time-sensitive bits of information in a simple way that coordinates behavior. For instance, high prices signal scarcity and discourage people from consuming too much of an item. A centrally-planned system would have much more difficulty responding quickly to such constantly changing factors.
While many glorify laissez-faire and the role free markets play in efficiency, it is also true that government provides an important underlying structure. Without a just legal system in place to protect property rights and enforce contracts, it is much harder to do business. Government is also often responsible for basic infrastructure such as roads and bridges that facilitate the transportation and interactions needed to carry on daily business. Some would call these instances of market failure.
Market failure is defined as a situation where the market operates inefficiently when left on its own. For example, if one person paid for the public good of hiring an army, no one in that locale would have an incentive to contribute because they would already get protection for free. Limited common resources (e.g., natural resources) can risk depletion if everyone uses as much as they want without any motivation to conserve them for others. Monopolies left unchecked may raise their prices and drop production to gain extra profit. Many believe government oversight is the solution to these problems.
While some cases may warrant intervention, government is not a guarantee of efficiency. Neither is it likely that the government will limit intervention only to cases of true market failure. Instead, implementing Keynesian strategies of deficit spending in an attempt to stimulate the market and create jobs are commonplace. Some basic calculation suggests that these routes may be less than efficient when comparing money spent with the number of jobs created. Another problem is government subsidies distorting the normal price signals and creating extra demand of a scarce resource.
Though perfect efficiency is impossible to attain, it can be a helpful ideal to work toward in business, government, and personal life. This topic explains the meaning of economic efficiency and investigates the best routes to achieving it on both a micro and macro level.
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