Achieving Allocational Efficiency: Key Concepts and Requirements

What Is Allocational Efficiency?

Allocational or allocative efficiency is an efficient market whereby all goods and services meet the needs and wants of society. Allocative efficiency means resources are used where their marginal benefit equals their marginal cost to society. The market prices of goods and services reflect the efficient market. Allocative efficiency occurs where the supply and demand curves cross, the equilibrium point.

How Allocational Efficiency Drives Economic Growth

Allocational efficiency occurs when organizations in the public and private sectors spend their resources on projects that will be the most profitable and do the most good for the population, thereby promoting economic growth.

When all of the data for a market is accessible, companies can make accurate decisions about what projects might be most profitable, and manufacturers can concentrate on producing products most desired by the general population.

In economics, allocative efficiency materializes at the intersection of the supply and demand curves. At this equilibrium point, allocative efficiency exists for a firm producing the output for which the price is equal to the marginal cost of production.

Key Conditions for Achieving Allocational Efficiency

In an efficient market, all important data is available to everyone and reflected in market prices. For the market to be efficient, it must be both informationally efficient and transactionally or operationally efficient. When a market is informationally efficient, all necessary and pertinent information about the market is readily available to all parties involved. In other words, no parties have an informational advantage over any other.

Meanwhile, all transaction costs are reasonable and fair when a market is transactionally efficient. This ensures that all transactions are equally executable by all parties and not prohibitively expensive to anyone. If these conditions of fairness are met and the market is efficient, capital flows will go to where they will be the most effective and provide an optimal risk/reward scenario for investors.

The Bottom Line

Allocational efficiency means using resources effectively to maximize satisfaction in the economy. It ensures that resources are used so that their marginal benefit to society is equal to their marginal cost. For a firm or producer, allocative efficiency happens when the price of the output is equal to the marginal cost of production.

Correction—July 31, 2023: A previous version of this article inaccurately compared allocational efficiency to distributive efficiency, the equitable distribution of resources. The article was edited to clarify that allocation efficiency is the optimal distribution of goods in an economy to meet the needs and wants of society where marginal social cost is equal to the marginal social benefit.