Principles of Economics/Allocation

Scarcity, Allocation, and Markets

There is a scarcity of almost everything that brings people happiness. Economics is the analysis of how a society determines how it will distribute, or allocate, its scarce goods to a population, and to a set of purposes that has an infinite desire for more. This is the first and most fundamental reason why economics is sometimes referred to as "the dismal science": never can all desires be satisfied.

Society accomplishes its allocation through market system or/and command system:

• Market systems use prices as signals to allocate its resources.
• Command systems make use of political choice to allocate its resources.

For our purposes, we shall focus on explaining how market allocation functions.

Productive and Allocative Efficiency

Through these means, society strives to achieve both productive efficiency and allocative efficiency.

An example of productive inefficiency is when a method of production yields the same as another that uses less of any resource but does not use more of any other resource. Hence, there would be no reason to use the less productive method.

An example of allocative inefficiency is when a method of production uses more of a certain resource and less of another than another method that costs more to society overall. Even if it is productively efficient, the resources are not used in the best distribution -- the allocation is inefficient. In this situation, the inefficient method should be swapped for the more efficient method by a redistribution of which combination of resources is used for a certain mode of production.

Another interpretation of allocative inefficiency is the distribution of goods to members of society in a way that yields less than optimal happiness. This interpretation is almost never achieved but is nevertheless the goal toward which economists strive.

Productive efficiency must be satisfied before allocative efficiency may be.