Definition of ceteris paribus
may not want to buy the currency – despite
Ceteris paribus is a Latin phrase meaning
‘all other things remaining equal’
The concept of ceteris paribus is important
in economics because in the real world it is
usually hard to isolate all the different
variables.
Assuming ceteris paribus allows us to
simplify economics – we can understand
how something like higher price will affect
– demand – ignoring all other factors
which might complicate the outcome.
Example of Ceteris Paribus in
Economics
1. An increase in interest rates will
‘ceteris paribus’ cause the demand
for loans to fall. (Higher interest
rates increase the cost of borrowing
so there will be less demand for
loans. However, if confidence was
high, people might still want to
borrow more. Ceteris paribus
assumes things like confidence
remain the same.)
2. Ceteris paribus – higher oil prices
should lead to less demand for oil.
3. Ceteris paribus – higher interest
rates should lead to lower
economic growth.
4. Ceteris paribus – higher prices of
coffee should encourage growers to
try and increase the supply of
coffee.
Importance of ceteris paribus
In the real world, it is very hard to isolate
only one factor. For example, if we look at
exchange rates, we would expect higher
interest rates (ceteris paribus) to cause an
appreciation in the currency.
But, in the real world, there will be many
other factors affecting exchange rates. For
example, if there was a lack of confidence
in the countries economy, then investors
higher interest rates.
However, by isolating the other factors, we
can consider how higher interest rates are
likely to have an effect and understand the
impact of higher interest rates – ignoring
all the other complicating factors.
The Major Difference Between Scarcity and
Shortage in Economics
Difference Between Scarcity and Shortage in
Economics
In economics, 'scarcity' and 'shortage' have
different meanings. Almost all resources are
scarce, since man does not have the ability to
create natural resources. On the other hand,
shortage of any resource can be created by
man, by controlling the supply, though
resources are available to satisfy the current
demand. Buzzle talks about difference
between the aforementioned terms in detail.
Time and Tide Waits for None
Time is one of the most precious and scarce
resources. All living beings come with a
limited lifespan, time is scarce for all of us.
Hence, we plan all our activities within a given
time-frame. However, when we say that time
is short for a certain activity, we actually have
time, but we prefer to spend it on some other
task rather than that activity. That is why the
interest rates for loans differ for different
time periods. We commonly refer to it as
'time-value of money'.
'Scarcity' and 'Shortage', though both words
are fairly common and seem synonymous,
they are usually misinterpreted. In layman's
terms, they may be used interchangeably, but
in the field of economics, they're completely
different terminologies. This Buzzle article will
delve deeper to understand the difference
between the two terms along with examples.
Scarcity of Resources
In economics, when we state that something
is scarce, it implies that something is available
in limited quantity naturally. It does not mean
short-term or temporary unavailability.
Scarcity is permanent in nature. All nations
face economic problems because resources
are scarce, and wants unlimited. Hence, every
economic system has to answer this question
of scarcity, and accordingly, plan for the
production requirements. Since they are
scarce, they are available free of cost, hence,
those who want to satisfy their wants have to
forgo something. The modern economic
system uses 'money' as the medium of
exchange. These resources are scarce, hence
have to be used judiciously. They cannot be
created more than available. Of course,
alternatives to scarce resources can be
created; however, they also need utilization of
other resources.
The principle behind this is 'Man cannot
create matter'. He simply converts the form,
for his own utility. All resources are scarce and
answering this question of scarcity, and
meeting the wants, is the basic function of all
economic systems. He employs the factors of
production to produce different types of
goods, using the scarce resources.
Examples of Scarce Resources
Water, land, oil, natural gas, minerals, etc.,
are scarce resources. That explains why we
have to pay for them, despite being available
naturally.
Every time you spend, something is scarce,
you lose the opportunity of utilizing it for
some other purpose. This is called the
'opportunity cost'. Of course, the degree of
scarcity is different for different goods.
Shortage of Resources
The market forces of demand and supply
determine the prices of a product. Shortage
can be termed in a simple manner as a
situation when there is more demand than
supply in the market. This means that
shortage is man-made. If the sellers and
producers want, they can increase the supply
of resources in the market; however, they do
not do so, to push the prices of the product.
When the market prices reach their desired
level, they pump in the resources in the
market. However, a shortage may not be
deliberately created by suppliers, it may also
be created by natural calamities, war,
emergency situations, etc.
Examples of Resource Shortage
If traders go on a strike in protest of levying of
a tax, and shut their shops for almost a week,
there will be a shortage of products due to
the strike, and the consumers will not be able
to buy goods, despite the shops being stocked
with them.
To push up the prices, suppliers may use
clever techniques. For non-perishable
products, they can stock the items and create
a shortage of goods, until the prices rise. With
development in preservation techniques, they
can even stock perishable items.
There might be a natural calamity, such as
drought or flood, due to which crops might be
lost, and until food is supplied from other
areas, there will be shortage of food in the
affected area.
Things to Ponder
► Scarcity of Air ?
The air we breathe is available free of cost.
However, with increasing pollution of air, you
can say that 'clean air' is scarce. Will there
come a time when we will have to pay for
clean air?
► Water-Shortage
With increasing shortage of water in different
areas of the world, the idiom, 'spend money
like water' will soon become redundant.
Rather, in times of drought, you can say, 'You
have to spend money like water, on buying
water!' Paradoxical, ain't it?
► Shortage of Money
'Money' is a highly misconstrued term.
'Money' as a good (entity), is neither the end
nor the requirement. Money is simply a
medium of exchange that has been
introduced due to the limitations of the barter
exchange system. Thus, we cannot simply
solve the economic problems of any nation by
introducing more money in the market.
Money is not freely available, and its
circulation is determined by regulatory
bodies. Though money provides 'purchasing
power', it does not satisfy your basic wants.
You need money to buy them, because it is an
accepted medium of exchange. Hence,
money, though man-made, is kept scarce.
Liquidity in the market can be determined by
banks and other regulatory authorities.
From the above, we can draw an inference
that scarcity is natural and permanent,
whereas shortage is man-made and
temporary. Almost all resources are scarce,
but shortage is caused due to the market
situations or other temporary reasons.
Whatever it may be, as a human being, it is
our moral responsibility to preserve the
natural resources of the Earth for our future
generations. With the alarming rate of
depletion of resources, it's time, we do a
reality check, and do our bit for the sake of
humanity.
Ayon kay Abraham Maslow, ang buhay ng
isang indibidwal ay naglalayon na makamit
ang mga pangangailangang makapagbibigay
daan tungo sa tinatawag na self-actualization.
Ang pinaka payak na pangangailangang
kailangang matugunan ay ang para sa pisikan
na pangangailangan. Mayroong limang bahagi
ang modelo ni Maslow at ito ay nahahati sa
dalawang pangangailangan, ang deficiency
needs at growth needs. Ang mga apat na
baiting mula sa pinakamababang nibel ay
tinatawag na D-needs o deficiency needs. Ang
mga pangangailangang ito ang nagbibigay
dahilan sa ibang tao na makamit ang mga
ibang bagay. Kapag hindi nakamit ang mga ito,
kikilos at kikilos ang tao nang sa gayon ay
makamtan lamang ang mga ito. Halimbawa:
Kung walang pagkain ang isang tao, mas lalo
siyang gugutumin at mas lalo nitong gusting
makamit na dapat siya ay mabusog.
Habang ang nasa tuktok naman ay tumutukoy
sa tinatawag na self-actualization kung saan
ang isang tao ay nagnanais umiral sa pinaka
puro nitong porma. Ang tao ay nais makamit
ang mga kakayahang tanging siya lamang ang
makapagpapaunlad.
Ang Kabuuang Pambansang Produkto o Gross
National Product ay ang halaga ng lahat ng
mga produkto at serbisyo sa isang taon na
sinuplay ng mga residente ng isang bansa. Ito
ay ang paglalaan ng produksiyon sa pag-aari
at isinasaalang-alang din ditto ang kwalitibong
kalakal at pagbababuti sa ilang aspeto ng
pang-serbisyo.
What is 'Opportunity Cost'
Opportunity cost represents the benefits an
individual, investor or business misses out
on when choosing one alternative over
another. While financial reports do not
show opportunity cost, business owners
can use it to make educated decisions
when they have multiple options before
them.
BREAKING DOWN 'Opportunity
Cost'
When assessing the potential profitability
of various investments, businesses look for
the option that is likely to yield the
greatest return. Often, they can determine
this by looking at the expected rate of
return for an investment vehicle. However,
businesses must also consider the
opportunity cost of each option. Assume
that, given a set amount of money for
investment, a business must choose
between investing funds in securities or
using it to purchase new equipment. No
matter which option the business chooses,
the potential profit it gives up by not
investing in the other option is the
opportunity cost.
Formula for Calculating
Opportunity Cost
This is the difference between the expected
returns of each option:
Opportunity cost = return of most lucrative
option not chosen - return of chosen option
Option A in the above example is to invest
in the stock market hoping to generate
returns. Option B is to reinvest the money
back into the business expecting newer
equipment will increase production
efficiency, leading to lower operational
expenses and a higher profit margin.
Assume the expected return on investment
in the stock market is 12 percent, and the
company expects the equipment update to
generate a 10 percent return. The
opportunity cost of choosing the
equipment over the stock market is 12
percent - 10 percent, which equals 2
percentage points.
Opportunity cost analysis also plays a
crucial role in determining a business's
capital structure. While both debt and
equity require expense to compensate
lenders and shareholders for the risk of
investment, each also carries an
opportunity cost. Funds used to make
payments on loans, for example, are not
being invested in stocks or bonds, which
offer the potential for investment income.
The company must decide if the expansion
made by the leveraging power of debt will
generate greater profits than it could make
through investments.
Because opportunity cost is a forward-
looking calculation, the actual rate of
return for both options is unknown.
Assume the company in the above
example foregoes new equipment and
invests in the stock market instead. If the
selected securities decrease in value, the
company could end up losing money rather
than enjoying the expected 12
percent return. For the sake of simplicity,
assume the investment yields a return of 0
percent, meaning the company gets out
exactly what it put in. The opportunity cost
of choosing this option is 10% - 0%, or
10%. It is equally possible that, had the
company chosen new equipment, there
would be no effect on production
efficiency, and profits would remain
stable. The opportunity cost of choosing
this option is then 12 percent rather than
the expected 2 percent.
It is important to compare investment
options that have a similar risk. Comparing
a Treasury bill, which is virtually risk-
free, to investment in a highly volatile
stock can cause a misleading calculation.
Both options may have expected returns of
5 percent, but the U.S. Government backs
the rate of return of the T-bill, while there
is no such guarantee in the stock market.
While the opportunity cost of either option
is 0 percent, the T-bill is the safer bet when
you consider the relative risk of each
investment.
Using Opportunity Costs in Our
Daily Lives
When making big decisions like buying a
home or starting a business, you will
probably scrupulously research the pros
and cons of your financial decision, but
most of our day-to-day choices aren't made
with a full understanding of the potential
opportunity costs. If they're cautious about
a purchase, most people just look at their
savings account and check their balance
before spending money. Mostly, we don't
think about the things we must give up
when we make those decisions.
However, that kind of thinking could be
dangerous. The problem lies when you
never look at what else you could do with
your money or buy things blindly without
considering the lost opportunities. Buying
takeout for lunch occasionally can be a
wise decision, especially if it gets you out
of the office when your boss is throwing a
fit. However, buying one cheeseburger
every day for the next 25 years could lead
to several missed opportunities. Aside
from the potential health effects, investing
that $4.50 on a burger could add up to just
over $52,000 in that time frame, assuming
a very doable 5 percent rate of return.
This is just one simple example, but the
core message holds true for a variety of
situations. From choosing whether to
invest in "safe" treasury bonds or deciding
to attend a public college over a private
one to get a degree, there are plenty of
things to consider when deciding in your
personal-finance life.
While it may sound like overkill to think
about opportunity costs every time you
want to buy a candy bar or go on vacation,
it's an important tool to use to make the
best use of your money.
What is the Difference Between a
Sunk Cost and an Opportunity
Cost?
The difference between a sunk cost and an
opportunity cost is the difference between
money already spent and potential returns
not earned on an investment because one
invested capital elsewhere. Buying 1,000
shares of company A at $10 a share, for
instance, represents a sunk cost of
$10,000. This is the amount of money paid
out to make an investment and getting that
money back requires liquidating stock at or
above the purchase price.
Opportunity cost describes the returns that
one could have earned if he or she invested
the money in another instrument. Thus,
while 1,000 shares in company A might
eventually sell for $12 a share, netting a
profit of $2,000, during the same period,
company B rose in value from $10 a share
to $15. In this scenario, investing $10,000
in company A netted a yield of $2,000,
while the same amount invested in
company B would have netted $5,000. The
$3,000 difference is the opportunity cost of
choosing company A over company B.
The easiest way to remember the
difference is to imagine sinking money
into an investment, which ties up the
capital and deprives an investor of the
opportunity to make more money
elsewhere. Investors must take both
concepts into account when deciding
whether to hold or sell current
investments. An investor has already sunk
money into investments, but if another
investment promises greater returns, the
opportunity cost of holding the
underperforming asset may rise to where
the rational investment option is to sell and
invest in a more promising investment
elsewhere.
What is the Difference Between considered the value of the next best
Risk and Opportunity Cost? alternative.

The basic formula for opportunity cost is:

In economics, risk describes the possibility
that an investment's actual and projected
what you are sacrificing / what you are
returns are different and that the investor
gaining = the opportunity cost
looses some or all of the principle.
Opportunity cost concerns the possibility
Because there are so many variables to
that the returns of a chosen investment are
consider (explicit costs, time, job specialty
lower than the returns of a forgone
etc.) when comparing going to college and
investment. The key difference is that risk
going to work we are going to use a more
compares the actual performance of an
simplified, yet perhaps less applicable,
investment against the projected
example. Assume you have the option
performance of the same investment, while
between buying three laptops or, buying
opportunity cost compares the actual
six video cameras. Your money is scarce
performance of an investment against the
so you have to choose between these two
actual performance of a different
options. Let’s figure out the opportunity
investment.
cost of choosing laptops over video
cameras is. You are giving up 6 video
Opportunity cost is a theory in
cameras in exchange for 3 laptops. The
microeconomics that measures the value of
equation looks like this:
two alternative choices to show what will
be lost in the pursuit of one of these
6 video cameras / 3 laptops = 2 video
options. If microeconomics isn’t you’re
cameras per laptop
thing try this course in micro and macro-
economics for a refresher. To demonstrate
This indicates that you sacrifice 2 video
the concept behind an opportunity cost,
cameras for every laptop gained. Which
we’ll use the example of going to college
means the opportunity cost of choosing
after high-school versus going straight to
laptops over video cameras is 2.
work. On one hand, going to college
means you either won’t have time to work,
Now, let’s calculate the opportunity cost
or you’ll work minimal hours and won’t
for choosing video cameras over laptops.
make much money. If you decide to go
We will use the same equation as above,
straight to work you will be making much
except we put laptops in the “giving up”
more money than you would in college.
spot of the equation and video cameras in
However, the time invested into getting an
the “gaining” spot.
education is worth more than the money
you would make otherwise. Once you have
3 laptops / 6 video cameras = ½ laptops
a degree you are more marketable to the
per video camera
global workforce which means you’re
likely to make more money than you ever
So now we can place value on how much
would if you didn’t get the education.
we can get for our money. We see that for
every laptop we purchase, we’re getting
These two options each have their
two video cameras. This would be the best
opportunity cost and thus allow us to
bang for our buck.
understand the value of what we sacrifice,
and what we produce, by selecting one or
Now that you’ve acknowledged the
the other. The opportunity cost is actually
opportunity cost of each option you can
understand what you are giving up in the
pursuit of another option. Learn how to
master decisions in this Cognitive Biases
course.
Making decisions can be overwhelming,
especially when you are seemingly on the
fence about the outcomes of choosing one
path over another. In the course Creative
Problem Solving you can learn tips to
make decision-making easier. When I
lived in Colorado I worked as a barista at a
coffee shop for minimum wage ($8/hr). It
was a good gig, but ready for change, I
began to pursue freelancing. I assessed the
amount of money I was made working at
the coffee-shop and then compared to the
money I would make pursuing a
freelancing career (approximately $20/hr).
The opportunity cost formula for choosing
the barista job over freelancing looked like
this:
what I sacrifice / what I gain =
opportunity cost
$20 freelancing / $8 barista = $2.5 per
hour
So, for every $1.00 I made at the coffee
shop, I could be making $2.50 while
freelancing. I then did the reverse
equation. What is the opportunity cost for
choosing freelancing over being a barista?
$8 barista / $20 freelancing = $0.40
per hour
So for every $1.00 I could make
freelancing I was only making $0.40 for
being a barista.
Of course, while looking for work I wasn’t
going to be making any money but once I
found work I knew that the amount I could
make in addition to the benefits of making
my own schedule and being able to travel
were going to outweigh the value of my
current meager wages. This was my own
practical application of the opportunity
cost theory. It worked. Find out how to
become your own employer through
freelance writing in this informative
article: Freelance Copy-writing Career.
When it comes managing economic
decisions there are many methods you can
use to make an educated choice. In the
Chartered Economist course you can learn
a general overview of managerial
economic concepts to help you in your
personal or business life.
no ang kapitalismo?
Mayroon tayong iba’t ibang uri ng
sistemang pang ekonomiya na siyang
nagtatakda kung paano ang mga tao ay
kumikita sa kanilang mga negosyo.
Halimbawa diyan ay ang kapitalismo,
komunismo at sosyalismo. Ang arikulong
ito ay naka pokus sa kapitalismo bilang
sistemang pang ekonomiya. Ano ang
kapitalismo? Ang kapitalismo ay isang
sistemang pang ekonomiya nna kung saan,
ang mga resources na ginagamit sa
paggawa ng mga produkto ay
pinagmamay-ari ng pribadong institusyon.
Ang produksyon ay para sa kita. Sa
sistemang ito, ang mga indibidwal ay may
kalayaang magsagawa ng negosyo habang
malaya rin silang pinakikinabangan ang
kanilang kita. Ag kapitalismo ay kapit sa
bawat tao na nagnenegosyo nsa ilalim ng
sistemang ito, kaya ang mga negosyante at
ang kanilang mga empleyado ay pantay-
pantay lamang sa sistemang kapitalismo.
Kung pag uusapan ang pagpapatakbo ng
negosyo, ang kapitalismo ay nagbibigay
ng higit na kalayaan sa may-ari ng
negosyo. Maliban sa pagbabayad ng buwis
at pamantayang mga batas, ang
pamahalaan ay walang kontrol sa kung
paano patatakbuhin ng may ari ang
negosyo at kung paano nila gagamitin ang
kanilang kita.
Pagbabayad ng buwis
Sa kapitalismo, may mga buwis na dapat
bayaran. Ang buwis ay nakatakda at hindi
kailangang ibigay ng mga negosyante ang
kabuuang kita nila sa gobyerno. Ang
kapitalismo ay nagbibigay ng
pinakamataas na antas ng kontrol at
kalayaan kumpara sa iba pang mga
sistemang pang ekonomiya kung buwis
ang pag-uusapan. Halimawa, sa ibang
sistemang pang ekonomiya, ang buwis ay
maaaring maging mataas, 50% o higit pa!
Sa ilalim ng kapitalismo, ang buwis ay
itinatakda base sa uri ng negosyo, kung ito
ba ay pag-aari ng iisang tao lamang (sole
proprietor), limited liability company
(LLC) or korporasyon. Ibinabatay din ang
buwis sa dami ng kita ng isang negosyo.
Dahil sa mas mababa ang buwis sa
sistemang ito, ang natitirang kita sa mga
negosyante ay magpapalakas ng gana nila
para magpursiging palaguin pa ang
kanilang kumpanya.
Halimbawa ng kapitalismo
Halimbawa ay nagmamay-ari ka ng isang
maliit na taniman ng kalabasa. Nalaman
mong ang pinaka magandang paraan ng
pagbebenta ng kalabasa ay ang
pagkakaroon ng taunan na event kung saan
papayagan mo ang mga pamilya na
magbisita at mag enjoy sa loob ng iyong
taniman maghapon, na pinipitas ang sarili
nilang kalabasa. Dahil ikaw ay bahagi ng
lipunang kapitalista, pwedeng pwede
mong ialok ang serbisyong ito, mag takda
ng bayad sa pagbisita, kung magkano ang
ipapataw mo sa bawat mapipitas na
kalabasa at itago ang kita na iyong
mkukuha.
Sa isa pang halimbawa, ikaw ay nag
mamay-ari ng isang matagumpay na
restaurant. Ikaw ay may 30 empleyado na
kumikita ng arawang kita at malaking tip
galing sa mga kostumer. Ang iyong mga
empleyado ay kalahok sa sistemang
kapitalismo dahil sila ay may karapatang
kunin at itago ang kita nila. Ang kita nila
ay depende sa sipag nila at tip na
ibinibigay ng mga kostumer. Kaya, walang
limit kung tungkol sa kung ilan ang pwede
nilang kitain, at malaya silang gamitin ang
perng kinita nila, sa anumang paraan na
gugustuhin nila.
Dahil sa kapitalismo, ang mga negosyo ay
may kakayahang magpalago hanggang sa
pinapayagan ng merkado. Halimbawa, ang
iyong restaurant ay maaaring umunlad
hanggang sa ito ay maging ilang restaurant
o maging chain store sa buong bansa, kung
mayroong demand sa pagkaing linuluto sa
restaurant na ito. Ang kapitalismo ay may
iilan lamang na mga limitasyon na
maaaring magpabagal sa pag lago ng isang
negosyo, kaya mas maganda ang
kapitalismo kumpara sa iba pang mga
sistemang pang ekonomiya. Ang mga
halimbawang ating ginamit ay sa ga
maliliit na negosyo lamang, subalit ang
kapitalismo ay kapit din sa malalaking
mga korporasyon.
What is 'Economic Efficiency'
Economic efficiency implies an economic
state in which every resource is optimally
allocated to serve each individual or entity
in the best way while minimizing waste
and inefficiency. When an economy is
economically efficient, any changes made
to assist one entity would harm another. In
terms of production, goods are produced at
their lowest possible cost, as are the
variable inputs of production.
BREAKING DOWN 'Economic
Efficiency'
Some terms that encompass phases of
economic efficiency include allocational
efficiency, production efficiency and
Pareto efficiency. A state of economic
efficiency is essentially theoretical; a limit
that can be approached, but never reached.
Instead, economists look at the amount of
loss, referred to as waste, between pure
efficiency and reality to see how
efficiently an economy is functioning.
Economic Efficiency and Scarcity
The principles of economic efficiency are
based on the concept that resources are
scarce. Therefore, there are not sufficient
resources to ensure that all aspects of an
economy functioning at their highest
capacity at all times. Instead, the scarce
resources must be distributed to meet the
needs of the economy in an ideal way
while also limiting the amount of waste
produced. The ideal state is related to the
welfare of the population as a whole with
peak efficiency also resulting in the
highest level of welfare possible based on
the resources available.
Economic Efficiency and Welfare
Measuring economic efficiency is often
subjective, relying on assumptions about
the social good, or welfare, created and
how well that serves consumers. At peak
economic efficiency, the welfare of one
cannot be improved without subsequently
Definition of efficiency
Efficiency is concerned with the optimal production and distribution of these scarce
resources.
There are different types of efficiency
1. Productive efficiency
lowering the welfare of another. In this
regard, welfare relates to the standard of
living and relative comfort experienced by
people within the economy.
Even if economic equilibrium is reached,
the standard of living of all individuals
within the economy may not be equal.
Pareto’s efficiency does not include issues
of fairness or equality among those within
a particular economy. Instead, the focus is
purely on reaching a point of optimal
operation in regards to the use of limited or
scarce resources. It states that efficiency is
obtained when a distribution strategy
exists where one party's situation cannot
be improved without making another
party's situation worse.
Factors for Analysis of Economic
Efficiency
Basic market forces like the level of prices,
employment rates, and interest rates can be
analyzed to determine the relative
improvements made toward economic
efficiency from one point in time to
another. The amount of waste during the
production of goods and services can also
be considered if the current allocation of
resources is ideal in regards to consumer
demand.
This occurs when the maximum number of goods and services are produced with a given
amount of inputs. This will occur on the production possibility frontier. On the curve, it is
impossible to produce more goods without producing fewer services. Productive efficiency
will also occur at the lowest point on the firm’s average costs curve (Q1)

See: Productive Efficiency

2. Allocative efficiency

This occurs when goods and services are distributed according to consumer preferences. An
economy could be productively efficient but produce goods people don’t need this would be
allocative inefficient.

Allocative efficiency occurs when the price of the good = the MC of production. This occurs
at an output of 80, where price £11 = MC.

At an output of 40, The price £15 is much greater than MC of £6 – there is

underconsumption.

See: Allocative Efficiency

3. X inefficiency

This occurs when firms do not have incentives to cut costs, for example, a monopoly which
makes supernormal profits may have little incentive to get rid of surplus labour.

If a firm’s average costs are higher than potential – then we are x-inefficient.

See: X Inefficiency

4. Efficiency of scale

This occurs when the firms produces on the lowest point of its long-run average cost (Q2)
and therefore benefits fully from economies of scale

5. Dynamic efficiency This refers to efficiency over time, for example, a Ford factory in
2010 may be very efficient for the time period, but by 2017, it could have lost this relative
advantage and by comparison would now be inefficient. Dynamic efficiency involves the
introduction of new technology and working practices to reduce costs over time.
6. Social efficiency

This occurs when externalities are taken into consideration and occurs at an output where the
social cost of production (SMC) = the social benefit (SMB)

Social efficiency occurs at an output of 16 – where SMB = SMC

7. Technical efficiency

This requires the optimum combination of factor inputs to produce a good: it is related to
productive efficiency.

8. Pareto efficiency

A situation where resources are distributed in the

most efficient way. It is defined as a situation
where it is not possible to make one party better
off without making another party worse off.

9. Distributive efficiency
Concerned with allocating goods and services according to who needs them most. Therefore,
requires an equitable distribution.

Pareto efficiency, also known as "Pareto optimality," is an economic state where resources
are allocated in the most efficient manner, and it is obtained when a distribution strategy
exists where one party's situation cannot be improved without making another party's
situation worse. Pareto efficiency does not imply equality or fairness.

BREAKING DOWN 'Pareto Efficiency'

Pareto efficiency has broad implications in economics, particularly in game theory. Unlike
the predicted logical outcome of a prisoner's dilemma (participants choose selfishly and do
not achieve the best possible outcome), if an economic state is Pareto efficient, individuals
are maximizing their utility. The final allocation decision cannot be improved upon, given a
limited amount of resources, without causing harm to one of the participants.

Pareto efficiency does allow for a party to experience improvement, a process known as
Pareto improvement, but it must not come at the expense of any other party. For example, if a
company produces three products as part of its normal business operations, the addition of an
employee on one production line may result in higher outputs of that product without any
negative impact on the other two.

In contrast, if the company move one employee from one production line to another, there
may be an increase in productivity in one line. This may be offset by the decrease in the other
and, therefore, is not an example of Pareto efficiency since a negative outcome occurred.

Using Pareto Improvements to Reach Pareto Efficiency

A primary focus is on productive efficiency, where the production of goods has been
optimized for maximum output with optimal input and limited waste. As processes improve
internally, resulting in no external deficit, productive efficiency has increased. Once all areas
within a system have completed all of the Pareto improvements available, the system is said
to be an example of Pareto efficiency. Even when efficiency has been reached, that does not
mean that all participants in the system are achieving the same levels of production, only that
no other improvements can be made without a detriment to another.

Understanding Production Resources

When discussing the allocation of resources in the attempt to reach Pareto efficiency, many
items may be included as any restructuring that can lead to process improvement may be
considered a reallocation of resources. It can include tangible production materials as well as
any associated real estate, tools or equipment. Employees can also qualify as resources when
attempting to arrange an optimal balance. Further, distribution channels and shipping
methods can also be adjusted to reach peak efficiency.