The idea of efficiency is incredibly important in economics. In fact, without the idea
of economic efficiency, economics would be uninteresting, irrelevant, and probably even
To understand the idea of "economic efficiency," we must first understand the real
meaning of “value.” We all tend to think of monetary value, as measured by the price or
dollar cost of some good or service. But goods and services have monetary values only
because of a much more fundamental meaning of what value really is. Here's a definition
of what value really is. Value is psychic satisfaction that occurs in an individual human
mind. Consequently, value is a psychological perception.
Economic efficiency is the relationship of value gained compared to value forgone as
the result of a chosen action. Each time someone chooses an action, value is gained and
value is forgone. For example, if you choose to buy and eat a $1 cheeseburger, you gain
the psychic satisfaction of that act. But you forego the psychic satisfaction of whatever
else you could have enjoyed by spending a dollar on some other good or service.
According to the Fundamental Hypothesis of Economics (FHE), people always try
their best to choose efficiently, which means they choose actions for which they believe
the value gained will be greater than the value foregone. According to the FHE, people
never knowingly make choices that are inefficient before the fact, which would mean
value gained is less than the value they could have had with a different choice. Of
course, after the fact, human choices sometimes turn out to be inefficient, because people
can and do make mistakes, even about what they value. But before the fact, people
always choose to act efficiently, if they have a choice at all.
Because value is subjective and personal (e.g., beauty is in the eye of the beholder;
one person gathers what another discards; one person’s treasure is another’s trash), value
cannot be measured objectively or numerically. Moreover, the value enjoyed by one
person from consuming some good or services cannot be added to the value enjoyed by
some other person who consumes the same good. Value has no metric, no unit of
measure. This fact is important, because it rules out the possibility of adding up
individual values to get a measure of social value.
Individuals can rank order particular choice outcomes, but they cannot assign a
concrete, objective, numerical value to any particular prospective outcome. Individuals
can make statements such as “I prefer apples to bananas,” or “I like watching football
more than watching golf,” but people cannot make meaningful statements such as “I like
apples twice as much as bananas,” or “watching football gives me six times as much
satisfaction as watching golf.” With a little reflection, it’s easy to see that statements
about what “we value,” or what “everyone values,” or about “social value,” cannot be
given concrete meaning, because value is individual, personal, and subjective, and
because value has no concrete, unchanging metric.
In economics we think about three categories of economic efficiency. First, we think
about efficiency in choosing particular scarce resources (land, labor, and capital) to
produce particular goods and services. We achieve "productive efficiency" by using
scarce resources to produce the goods and services that people want most. People want
most what they value most. Second, we think about efficiency in choosing which goods
and services to consume. If Bobby gains more value from going to a movie than he
would from going to a football game, Bobby consumes efficiently by going to a movie.
Third, we think about the efficiency of who gets to consume particular goods and
services. If there is only one cookie to be consumed, and if Annie would gain more value
from consuming that cookie than Bobby would, we would say that Annie consuming the
cookie instead of Bobby would be economically efficient. Economists refer to that sort
of efficiency as “allocative efficiency.”
Economists study how people living together in a society choose to answer the three
fundamental question that all societies must somehow answer in a social context: (1)
what goods and services to produce using scarce resources, (2) how to produce them (i.e.,
what resources to use and what recipes or technologies to use), and (3) who gets to
consume the goods and services.
Of course, everyone agrees that people who live together in a society should
somehow answer these three questions to yield efficient outcomes. Did you notice the
“should”? Statements about what should be done or what ought to be done or what
would be best to do are sometimes called "normative statements." Does that mean that
economic efficiency is ultimately a matter of opinion? Yes. Because value is subjective
and personal, and because economic efficiency is a comparison of value gained to value
foregone due to some chosen action, judgments about whether a particular chosen action
is efficient must necessarily be subjective and personal.
But even though efficiency itself is normative, it is not correct to say that the
efficiency criterion for choosing actions is a normative criterion. The efficiency criterion
is a logical basis for choosing, which is why efficiency appeals to humans. After all, the
ability to reason logically is the penultimate characteristic of humans.. People want to
choose efficiently because it would be utterly illogical to do otherwise. The Fundamental
Hypothesis of Economics is really nothing more than a hypothesis that says people
choose logically. Seeking economic efficiency is logical.