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Allocative Efficiency in Economics: Definition & Example

Allocative Efficiency in Economics: Definition & Example
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Lesson Transcript
Instructor: Brianna Whiting
In this lesson, we will explore allocative efficiency, including its definition and how it works for the benefit of society. The lesson will conclude with a summary and a brief quiz.

Overview of Allocative Efficiency

At many points in our lives, we've all had to purchase a gift for someone. Sometimes those gifts are for a child. For example, have you ever gone birthday shopping for a five-year old? While you may not have been familiar with the hottest toy of the moment, your trip to the toy store might have shed some light on what to buy.

You see, some stores will only carry in-demand merchandise because those are the items that sell. Therefore, you can assume that the toy with the most inventory in stock is probably the hottest toy or the one in the greatest demand. This type of strategy is known as allocative efficiency, or social efficiency, and is commonly used in economics or social science.

So, what does allocative efficiency mean? If you think it has something to do with product availability and the use of limited resources, you're right. Allocative efficiency means that markets use scarce resources to make the products and provide the services that society demands and desires. The marginal benefit, or the amount of money a consumer will pay for a product, must equal its marginal cost, or how much a company has to spend to produce extra units of a good.

In other words, the cost of production must equal how much consumers value the product.

When Does Allocative Efficiency Occur?

It is also important to note that while not all individuals agree on what consumers demand or desire, as long as one group of people does not enjoy the benefits of a product at another group's expense, allocative efficiency occurs. For example, if the majority of people want red cars, companies will produce red cars to meet that need. This is not to say that some people wanted, or will not get, blue cars. It just means that fewer people wanted blue cars. Therefore, the company did its best to satisfy the needs of the majority of consumers by making products that were in high demand.

Key Principles of Allocative Efficiency

There are three key concepts associated with allocative efficiency, some of which we've just touched upon. They include the following :

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