Chapter 2: Problem 21

It is clear that productive inefficiency is a waste since resources are used in a way that produces less goods and services than a nation is capable of. Why is allocative inefficiency also wasteful?

Short Answer

Expert verified

Allocative inefficiency is considered wasteful as it means resources are not distributed in a way that maximizes society's total welfare or satisfaction. It reduces economic surplus, which represents total societal benefit from consumption, leading to a welfare loss. For instance, if a government invests significant resources in developing non-renewable energy sources instead of renewable ones, this represents allocative inefficiency. While non-renewable energy sources provide energy, they also have negative long-term environmental consequences, impacting overall societal well-being. Thus, a more efficient allocation of resources towards renewable energy could have resulted in higher societal benefits. In essence, when resources aren't allocated to maximize social benefits, opportunities for greater satisfaction are missed, causing long-term consequences and suboptimal outcomes for society.

Step by step solution

Understanding Allocative Inefficiency

Allocative inefficiency occurs when resources are not distributed in a way that maximizes the total welfare of society. In other words, the allocation of resources does not result in the highest possible satisfaction from consuming goods and services by individuals and businesses. This could mean that some resources may be allocated to an area where they have a lower value, while other areas remain unfulfilled.

Allocative Inefficiency and Economic Surplus

To better understand why allocative inefficiency is wasteful, let's introduce the concept of economic surplus. Economic surplus is the sum of consumer surplus and producer surplus. Consumer surplus is the difference between what consumers are willing to pay for a product and what they actually pay, and producer surplus is the difference between what producers are willing to sell their product for and what they actually receive for it. Allocative efficiency occurs when economic surplus is maximized.

The Welfare Loss

Allocative inefficiency leads to a welfare loss because resources are not utilized in a way that maximizes economic surplus, which represents total societal benefit from consumption. When resources are directed to goods and services that do not generate the highest possible welfare, society is left worse off than it could have been.

Example of Allocative Inefficiency

Consider an example where a government invests a significant amount of resources in developing non-renewable energy sources instead of investing in renewable energy sources. Although the non-renewable energy sources provide energy for consumption, they have negative long-term consequences for the environment, impacting the overall well-being of society. By allocating resources inefficiently in this manner, higher societal benefits could have been achieved by investing in renewable energy.

Conclusion

Allocative inefficiency is wasteful because it leads to a reduction in total welfare, including both consumer and producer surplus. When resources are not allocated in a way that maximizes overall societal benefits, opportunities for higher overall satisfaction are lost. Allocative inefficiency can have negative long-term consequences and may result in suboptimal outcomes for the society as a whole.