The economic problem is at the heart of the definition of economics Economics is the social science concerned with the problem of using scarce resources to obtain the maximum fulfillment of society’s unlimited wants. Economics is concerned with “doing the best with what we have.”
Economics is thus the social science that examines efficiency—the best use of scarce resources. Society wants to use its limited resources efficiently; it desires to produce as many goods and services as possible from its available resources, thereby maximizing total satisfaction.
To realize the best use of scarce resources, a society must achieve both full employment and full production. By full employment we mean the use of all available resources. No workers should be out of work if they are willing and able to work. Nor should capital equipment or arable land sit idle. But note that we say all available resources should be employed. Each society has certain customs and practices that determine what resources are available for employment and what resources are not. For example, in most countries legislation and custom provide that children and the very aged should not be employed. Similarly, to maintain productivity, farmland should be allowed to lie fallow periodically. And we should conserve some resources—fishing stocks and forest, for instance—for use by future generations.
The employment of all available resources is not enough to achieve efficiency, however. Full production must also be realized. By full production we mean that all employed resources should be used so that they provide the maximum possible satisfaction of our material wants. If we fail to realize full production, our resources are underemployed.
Full production implies two kinds of efficiency—productive and allocative efficiency. Productive efficiency is the production of any articular mix of goods and services in the least costly way. When we produce, say, compact discs at the lowest achievable unit cost, we are expending the smallest amount of resources to produce CDs and are therefore making available the largest amount of resources to produce other desired products. Suppose society has only $100 worth of resources available. If we can produce a CD for only $5 of those resources, then $95 will be available to produce other goods. This is clearly better than producing the CD for $10 and having only $90 of resources available for alternative uses.
In contrast, allocative efficiency is the production of that articular mix of goods and services most wanted by society. For example, society wants resources allocated to compact discs and cassettes, not to 45 rpm records. We want personal computers (PCs), not manual typewriters. Furthermore, we do not want to devote all our resources to producing CDs and PCs; we want to assign some of them to producing automobiles and office buildings. Allocative efficiency requires that an economy produce the “right” mix of goods and services, with each item being produced at the lowest possible unit cost. It means apportioning limited resources among firms and industries in such a way that society obtains the combination of goods and services it wants the most.
FULL EMPLOYMENT-Use of all available resources to produce want-satisfying goods and services.
FULL PRODUCTION-Employment of available resources so that the maximum amount of goods and services is produced.
PRODUCTIVE EFFICIENCY-The production of a good in the least costly way.
ALLOCATIVE EFFICIENCY-The apportionment of resources among firms and industries to obtain the production of the products most wanted by society (consumers).