Cost efficiency

economic-dictionary

The cost of efficiency or cost of efficiency is the economic loss caused by an inefficient allocation of resources.

The cost of efficiency is also often called a deadweight loss and can occur when the market for a good or service is not in market equilibrium. The cost of efficiency is characterized by the fact that the loss generated to one part of the transaction is not offset by the higher profits that the other may obtain.

Examples of efficiency costs

  • Monopoly: When there is a monopoly, fewer units are produced and a higher price is charged than in the competitive equilibrium. However, the loss of efficiency is not reflected in the higher price that consumers face but comes from the fact that units that consumers value are no longer produced and would be willing to pay the market price for them.
  • Taxes: When a tax is applied to a good or service, the price faced by consumers generally increases and the price received by suppliers falls. As a consequence, the production and sale of the good is reduced. The loss of efficiency generated by the tax comes from the fact that there are transactions that are valued and stopped while the government cannot collect for the sales that were not made.
  • Price caps and rent controls: discourages supply when consumers were willing to pay for goods or services. Price controls hurt both sellers and buyers.
  • Minimum wage: discourages the hiring of workers, especially the less qualified.

In many cases the loss of efficiency can be measured graphically. Thus, for example, in the case of monopoly, the loss of efficiency is measured as the area that results from the difference between the situation of perfect competition and the monopoly equilibrium.

When the market goes from a competitive equilibrium to a monopolistic one, part of the consumer surplus is transferred to the monopolist but there is a loss of efficiency that corresponds to the value of the units that stopped being sold.

Effectiveness

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