Productive Efficiency Definition: What Is Productive Efficiency? - 2021

Productive efficiency, also known as production efficiency, is the economic concept of producing the largest possible output from the available resources in an economy. Once a company or market reaches productive efficiency, creating any additional units would require reducing the production level of another product. Production efficiencies factor into decisions about resource allocation because maximizing economic efficiency for one market may lead to higher opportunity costs in another market. For example, if all of a food company's wheat reserves go toward making cereal, it may face higher opportunity costs to make crackers because it will have to source more wheat. Alternatively, the company could reduce the amount of cereal it produces, which would also let it produce crackers using its existing wheat supply. However, this would lower the economic efficiency of its cereal production. Productive efficiency often comes into play when a production process relies on scarce resources. In microeconomics, this could involve two industries competing for the same raw materials and ending up limited by similar externalities. As an example, consider the production of most rechargeable batteries, which require a steady supply of the minerals lithium and cobalt. When companies allocate these minerals toward the maximum production efficiency of car batteries, they reduce the available resources for other types of batteries that rely on the same core materials. If the car battery manufacturing process has reached its maximum productive efficiency, there will be higher marginal costs for any additional unit produced. In competitive markets, companies may be able to evade such situations by improving workflows, improving technical efficiency, and exploiting economies of scale. In the short run, they bump up against the limits of production efficiency. The production possibility frontier (PPF) refers to a graphic curve used in both macroeconomics and microeconomics to describe the output limits on two products that compete for the same finite resources. These resources can be physical materials such as wood or minerals. They can also refer to human capital, land, equipment, and production technology. A PPF is represented on an XY coordinate plane where the X-axis represents the production of one commodity and the Y-axis represents the production of a different commodity. The PPF appears as a curve that tracks these metrics concurrently. A production possibility frontier is calculated via the combination of inputs from both products. An increase in the production of one product will lead to a decrease in the other product because both products must be made using the same pool of finite resources. Productive efficiency and allocative efficiency measure common characteristics, but the two terms are not synonyms. - __Productive efficiency represents the maximum output of a product given scarce resources__. The production of any additional units results in opportunity costs—one of which is the reduced output of another product. This metric focuses entirely on monetary costs and resources. - __Allocative efficiency measures the distribution of goods and services__. Allocative efficiency is a state of market equilibrium where both producer and consumer benefit. Specifically, it means the marginal cost of production for each unit sold will equal the marginal benefit to the customer buying that good. To have true allocative efficiency, both producers and buyers must benefit from the overall condition of the market. On a macroeconomic level, this applies to entire societies such that producers benefit in an open market and consumers pay reasonable prices for an enhanced quality of life. - __A productive efficiency can also be an allocative efficiency__. A market can function at maximum productive efficiency and also provide allocative efficiency to producers and customers. However, this will only be the case if all parties benefit from the market conditions. If a market disproportionately favors either producers or purchasers, it does not offer allocative efficiency. - __Both efficiencies are limited by externalities__. A corporation or small business can do a great deal to improve its productive efficiency levels and reduce inefficiency. This includes ramping up its level of production, performing preventive maintenance on equipment, reducing factory downtime, tracking key performance indicators (KPIs), reimagining production lines, and incentivizing higher productivity levels among its workforce. However, even when a company streamlines and optimizes in every possible way, it can still be hampered by the production of another product that taps into its same supply chain. To optimize their unit costs, these companies—particularly manufacturing companies—must control the use of resources whenever possible. The goal is for the company to have an actual output rate that gets as close as possible to the ideal, or standard output rate. Get the [MasterClass Annual Membership](https://www.masterclass.com/) for exclusive access to video lessons taught by business luminaries, including Sara Blakely, Chris Voss, Robin Roberts, Bob Iger, Howard Schultz, Anna Wintour, and more. When a market is optimized to produce maximum output from a fixed amount of resources, economists describe it as having productive efficiency.