Efficiency
Introduction
Efficiency in economics isn’t just a buzzword—it’s a foundational concept that lies at the heart of how markets operate, resources are allocated, and policies are evaluated. This guide breaks down this pivotal idea, offering both students and instructors a clear, concept-rich gateway into its practical and theoretical importance.
At its core, efficiency is about the relationship between ends and means—getting the most out of limited resources and achieving goals with minimal waste. As Paul Heyne puts it (in the Concise Encyclopedia of Economics), an inefficient scenario suggests we’re using more resources than necessary to reach our objectives—or alternatively, that those same resources could achieve more outcomes with better use.
Definitions and Basics
Efficiency, by Paul Heyne, from the Concise Encyclopedia of Economics
To economists, efficiency is a relationship between ends and means. When we call a situation inefficient, we are claiming that we could achieve the desired ends with less means, or that the means employed could produce more of the ends desired….
New Keynesian Economics by N. Gregory Mankiw, from the Concise Encyclopedia of Economics
The heart of the new synthesis is the view that the economy is a dynamic general equilibrium system that deviates from an efficient allocation of resources in the short run because of sticky prices and perhaps a variety of other market imperfections….
Efficient Capital Markets, by Steven L. Jones and Jeffry M. Netter, from the Concise Encyclopedia of Economics
The efficient markets theory (EMT) of financial economics states that the price of an asset reflects all relevant information that is available about the intrinsic value of the asset. Although the EMT applies to all types of financial securities, discussions of the theory usually focus on one kind of security, namely, shares of common stock in a company….
Efficiency Wages and Unemployment: Do the Opposite, by Bryan Caplan at EconLog:
Suppose employers cannot perfectly monitor their employees. How can they maintain worker discipline? One route: Raise your employees’ wages so you can scare them by threatening to fire them if they cross the line. People worry a lot more about losing a good job than a crummy job.
If everyone does this, the result is some permanent involuntary unemployment. Wages do not fall in response to the labor surplus because at lower wages, employees would stop worrying about getting fired and start misbehavin’….
In the News and Examples
A Conversation with Harold Demsetz. In this illuminating conversation, Harold Demsetz unpacks how market coordination and property rights—not idealized models—underpin real-world economic efficiency.
Michael Munger on the Perfect vs. the Good. EconTalk podcast, April 24, 2023.
Michael Munger unpacks how economic efficiency shapes policy decisions—like minimum wage and rent control—while pitting ideological perfectionists against pragmatic incrementalists, revealing why economics often demands ‘the good’ over the unattainable ‘perfect.’
Richard McKenzie on Prices, EconTalk podcast, June 23, 2008.
Richard McKenzie of the University California, Irvine and the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles,talks with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination….
“The the Rise of the ‘Economic Style of Reasoning’,” by Donald Boudreaux. Econlib, April 3, 2023.
Boudreaux spotlights how cost–benefit logic and the idea of ‘efficiency’ gradually replaced ideals like equality and rights as the defining lens of U.S. policymaking.
Do you prefer cash or money as a gift? The Economics of Valentine’s Day, a LearnLiberty video.
Natural Resources, from the Concise Encyclopedia of Economics
The earth’s natural resources are finite, which means that if we use them continuously, we will eventually exhaust them….
They Clapped: Can Price-Gouging Laws Prohibit Scarcity? by Michael Munger. Econlib, January 8, 2007.
Hurricane “Fran” smashed into the North Carolina coastline at Cape Fear at about 8:30 pm, 5 September 1996. It was a category 3, with 120 mph winds, and enormous rain bands. It ran nearly due north, hitting the state capital of Raleigh about 3 am, and moving north and east out of the state by morning….
There were no generators, ice, or chain saws to be had, none. But that means that anyone who brought these commodities into the crippled city, and charged less than infinity, would be doing us a service….
A Little History: Primary Sources and References
Lionel Robbins, biography, from the Concise Encyclopedia of Economics
Robbins’ most famous book was An Essay on the Nature and Significance of Economic Science, one of the best-written prose pieces in economics. That book contains three main thoughts. First is Robbins’ famous all-encompassing definition of economics that is still used to define the subject today: “Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses.”…
Who coined the phrase “the dismal science”? The Secret History of the Dismal Science: Economics, Religion, and Race in the 19th Century, by David M. Levy and Sandra J. Peart. Econlib, January 22, 2001.
Everyone knows that economics is the dismal science. And almost everyone knows that it was given this description by Thomas Carlyle, who was inspired to coin the phrase by T. R. Malthus’s gloomy prediction that population would always grow faster than food, dooming mankind to unending poverty and hardship.
While this story is well-known, it is also wrong, so wrong that it is hard to imagine a story that is farther from the truth. At the most trivial level, Carlyle’s target was not Malthus, but economists such as John Stuart Mill, who argued that it was institutions, not race, that explained why some nations were rich and others poor….
Advanced Resources
Lecture Notes on Efficiency, by Bryan Caplan at GMU.edu:
… A situation is Pareto efficient iff the only way to make one person better off is to make another person worse off….
An Interview with N. Gregory Mankiw. May 2005
… I have been a believer in the repeal of the estate tax for a long time. I wrote a Fortune column on that probably seven or eight years ago. I favor repeal for two reasons. One is just simple economic efficiency. I’m a believer that we should try to move towards a consumption tax and the estate tax which is a tax on capital is fundamentally inconsistent with that. So from the standpoint of efficiency it’s a bad thing….
Some markets can be so efficient that new information is available instantly and a new market price evolves within seconds. Stock markets are a primary example. Fama on Finance, EconTalk podcast. January 30, 2012:
Eugene Fama of the University of Chicago talks with EconTalk host Russ Roberts about the evolution of finance, the efficient market hypothesis, the current crisis, the economics of stimulus, and the role of empirical work in finance and economics….