TEXT 5. Economic Policy. Efficiency

Economic theory helps us understand how the world works, but the formulation of economic policy requires a second step. We must have objectives. What do we want to change? Why? What is good and what is bad about the way the system is operating? Can we make it better? Such questions force us to be specific about the grounds for judging one outcome superior to another. What does it mean to be better? Four criteria are frequently applied in making these judgments: 1. Efficiency; 2. Equity; 3. Growth; 4. Market equilibrium.

Efficiency. In physics “efficiency” refers to the ratio of useful energy delivered by a system to the energy supplied to it. An efficient automobile engine, for example, is one that uses up a small amount of fuel per mile for a given level of power. In economics efficiency means allocative efficiency. An efficient economy is one that produces what people want and does so at the least possible cost. If the system allocates resources to the production of things that nobody wants, it is inefficient. When steel beams lie in the rain and rust because somebody fouled up a shipping schedule, this is inefficient. If a firm could produce its product using 25% less labor and energy without sacrificing quality, it is also inefficient.

To use the term more technically, an efficient change in the allocation of resources is one that at least potentially makes some people better off without making worse off. The clearest example of an efficient change is a voluntary exchange. If you and I each want something that other has and we agree to exchange, we are both better off, and no one loses. If a company reorganizes its production or adopts a new technology that enables it to produce more of its product with fewer resources, without sacrificing quality, this is an efficient change; at least potentially, the resources saved could be used to produce more of something.

Inefficiencies can arise in numerous ways. Sometimes they are caused by government regulations or tax laws that distort otherwise sound economic decisions. When only one firm exists in a market and competition is prohibited or nonexistent, the incentive damage are in no way held accountable for their actions, the incentive to minimize those damages is lost, the result is inefficient.

Answer the questions:

1. What does economics help us to understand?

2. What kind of questions should any government answer when formulating its economic policy?

3. What does the category of efficiency mean for economics?

4. Which four criteria for judging economic outcomes do you know?

5. If the system allocates resources for the production of things that nobody wants, is it efficient?

6. Is it good for economics if there is no competition in the market?

7. In what circumstances do inefficiencies arise in economy?

8. Why should we all increase the efficiency of national economy?

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