Allocational Efficiency

Published Aug 1, 2023

Definition of Allocational Efficiency

Allocational efficiency refers to the optimal allocation of resources in an economy that maximizes its overall welfare. It happens when resources are distributed in a way that produces what society wants at the lowest possible cost. That means, for every product or service, the resources are used in the best possible manner to meet the demand of the market.

Example

Suppose there is a small town with limited resources, and the local government is responsible for providing public goods and services to its residents. The town has a budget to spend on various projects and services.

To achieve allocational efficiency, the government conducts a survey to gather residents’ preferences and priorities. Based on the survey results, they identify the most essential needs of the community, such as better healthcare facilities, improved educational institutions, and enhanced public infrastructure.

The government then allocates the budget in a way that prioritizes the identified needs of the residents. For instance:

• A significant portion of the budget is allocated to improving healthcare services, as it was identified as a high-priority need by the majority of residents.
• Adequate funds are dedicated to enhancing schools and educational programs to cater to the community’s demand for quality education.
• Investments are made in upgrading public infrastructure, like roads and utilities, which are essential for the overall well-being and development of the town.

By allocating resources in response to the community’s preferences and needs, the local government achieves allocational efficiency. The resources are used in a way that maximizes social welfare, as the majority of residents receive the goods and services they value the most, leading to an improvement in overall living standards and well-being.

Why Allocational Efficiency Matters

Allocational efficiency is essential for achieving economic growth and success. When the resources are allocated efficiently, the economy can operate at its maximum potential, and the living standards of people can improve.

On the other hand, when resources are misallocated, it leads to a lack of productivity, leading to economic inefficiencies, and ultimately harming society’s welfare. Allocational efficiency is therefore a crucial factor in achieving optimum growth and development for an economy.