Wrong-Headed Notions of Efficiency

Most firms strive to be efficient in their operations. Few, however, distinguish between technological efficiency and economic efficiency.

Technological efficiency is when a firm strives to produce the most output with a given set of inputs. Economic efficiency, on the other hand, is when a firm produces its output at the least cost.

Because firms are profit-maximizing entities, profit maximization implies economic efficiency. If a firm is nor producing its output at the least cost, then it is not achieving its profit-maximizing potential.

Consider a firm that makes widgets and has the choice between making the widgets in either a  manual labour and some equipment, or in a plant which has more automated equipment and fewer workers. Either of these production systems could be deemed to be technologically efficient, provided there is no waste. However, neither would necessarily be economically efficient.

Firms should consider which of the production systems they could choose to employ is the most economically efficient. the one which is the most economically efficient will be that which produces output at the least cost.

The current acceleration of the use of robotic technology in manufacturing plants is due to the fact that this technology has now become economically efficient. Until relatively recently, robots were quite expensive – firms that employed them could not produce at the lowest cost as it was still more profitable to use labour in place of robots. Now, robotic technology has reached the point where its cost does support economic efficiency and increasingly firms can be expected to move in this direction.

When firms downsize, they are really revealing their lack of economic efficiency. The fact that they could produce their output with the excess labour means that they were not operating with economic efficiency.

Economically efficient supply always involves making choices about how best to combine labour with capital so that costs are minimized.


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