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Market Failure and Externalities: Question 6

Syllabus 7.3

Multiple choice A2 1 mark

Economists judge how well a market is performing partly by whether it achieves productive efficiency and partly by whether it achieves allocative efficiency. These are two distinct conditions.

Which of the following best describes productive efficiency, as distinct from allocative efficiency?

Choose an answer to check it, then compare with the worked solution below.
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Worked solution

Step 1: Recall the two definitions

Productive efficiency is achieved when a good or service is produced using the fewest possible resources for a given level of output. Equivalently, at the lowest possible cost per unit, so it is impossible to produce that output any more cheaply.

Allocative efficiency is a separate condition: it is achieved when price equals marginal cost (P=MCP = MC), so that resources are directed towards producing the combination of goods that society values most highly. A market can be productively efficient (producing cheaply) while still being allocatively inefficient (producing the wrong quantity), and vice versa.

Step 2: Check option B

Option B (“output is produced using the fewest possible resources, so it cannot be produced at any lower cost per unit”) is exactly the definition of productive efficiency.

Step 3: Rule out A, C and D

  • Option A describes allocative efficiency, not productive efficiency: P=MCP = MC is about directing resources to their highest-valued use, not about minimising the cost of producing a given output.
  • Option C describes profit maximisation. A firm can maximise its own profit, for example a monopolist restricting output to raise price, while still producing at a higher cost per unit than the lowest technically possible, so profit maximisation does not guarantee productive efficiency.
  • Option D describes consumer equilibrium (utility maximisation), a demand-side concept that says nothing about how cheaply a firm produces its output.

Final answer

Option B. Productive efficiency means producing at the lowest possible cost per unit. Option A instead describes allocative efficiency, and options C and D describe unrelated concepts (profit maximisation and consumer utility maximisation).