Efficiency Principle

  

Categories: Financial Theory, Econ

A main tenet of economics, the efficiency principle states that things are working most efficiently when the allocation of resources leads to marginal benefits that are equal to marginal social costs.

If marginal costs and benefits aren't equal, it means somebody owes somebody else...something. If a factory is pumping toxic fumes into the air, causing the neighborhood nearby to have a rate of lung cancer and costing them expensive medical bills, the company needs to pay for the cost that equals the cost that the neighborhood is incurring from the pollution to make things efficient.

Just like pollution can cause deadweight loss (the measured gap between reality and equilibrium), so too can a surplus or shortage of goods in the market. A surplus means the producer has too high of a quantity of goods, which is wasteful. A shortage means consumers want more, but can't have it, which is lost value to the economy. In a perfectly efficient world, supply equals demand, and marginal benefit equals marginal costs.

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