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Definition:  Allocative efficiency is an economic concept that occurs when the output of production is as close as possible to the marginal cost. In this case, the price the consumers are willing to pay is almost equal to the marginal utility they derive from the good or the service.

What Does Allocative Efficiency Mean?

What is the definition of allocative efficiency?  This concept represents the degree to which the marginal benefits is almost equal to the marginal costs. Hence, at the optimal level of efficiency, the marginal cost of the last unit is perfectly equal to the marginal benefit that consumers derive from the good or the service.

The basic principle of allocative efficiency is that it guarantees a proper allocation of resources based on the needs and wants of consumers. In economic terms, the allocative efficiency represents the utility derived from the consumption of a good or a service with respect to a certain level of price. Therefore, both producers and consumers benefit.

Allocative Efficiency Example

Let’s look at an example.

Example

Malcolm wants to buy a new car. However, he doesn’t know what brand would suit him the best or what color to choose. So, he goes to the car seller, and he asks for advice.

Most car retailers have in-demand vehicles, i.e. merchandise hat most consumers would buy or are willing to buy. Therefore, Malcolm assumes that red cars sells the most and are the ones with the greatest demand. If this stands true, then this represents the allocated efficiency, which suggests that the availability of cars is based on the limited resources of car retailers, who know what will sell the most. So, they provide what consumers need to sell more cars and realize a higher profit.

Malcolm’s marginal benefit is almost equal to the car retailer’s marginal cost, which represents the dollar amount that the car retailer will pay to acquire (produce) extra units of cars. Also, while not all consumers will agree on a red car, if a large group of consumers shows a preference for red cars, car retailers will choose to promote and sell this type of cars.

Summary Definition

Define Allocative Efficiency:  Allocative efficiency means managements across the economy is deploying resources in the most efficient manner to match customer preferences.


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