You will now find out what constitutes allocative efficiency and why the perfectly competitive markets you have just read about attain allocative efficiency. You will sometimes find differing uses of particular economic terms describing efficiency.
Table 10.1 provides a guide for interpreting these terms.
Given the imperfections of the health care market, can efficiency be achieved within a given health care system? This question is addressed by Cam Donaldson and Karen Gerard (2005) in the following extract from their book.
Activity 10.2
While reading, consider the following questions:
1 What is allocative (or social) efficiency?
2 Why is it a good thing for markets to be allocatively (socially) efficient?
Efficiency
Given the imperfections of the health care market, can social efficiency be achieved within a given health care system? The short answer is probably no, and the question then becomes how close can systems get to this outcome. In principle, social efficiency is an
uncontentious objective of any health care system because the objective seeks the greatest improvements in health from available resources. This is synonymous with what econo- mists term minimising ‘opportunity cost’, i.e. minimising the cost to society of achieving these health benefits.
Minimising opportunity cost is derived from the notion of scarcity and the need to make choices between competing claims on resources. In economic terms, the decision to commit resources to tackling a health problem denies society the opportunity of using these resources to tackle other health problems. Therefore, some opportunities for improving health remain unfunded. The gains forgone are called opportunity costs. It follows that costs are inextricably linked with benefits. The optimum, social goal in any health care market – regulated market – can be defined as: maximise benefits and minimise costs. To have resources deployed inefficiently would mean that these resources could be reallocated to increase output and thereby social welfare.
Achieving efficiency is therefore about comparing the costs (or resources spent) and benefits (or well-being produced) of competing health care interventions and ensuring that resources are allocated in such a way as to maximise health gains to society.
There are two levels of efficiency: ‘operational’ efficiency and ‘allocative’ efficiency. Each of these is based on ‘effectiveness’. These two types of efficiency and effectiveness represent different breadths of perspective, effectiveness being the narrowest and allocative effi- ciency the broadest. It is easier to talk about these levels because they apply to health care provision but it should be noted that they are important for evaluating changes in financing arrangements.
Table 10.1 Different types of efficiency
Category Definition Necessary (but insufficient)
conditions Operational efficiency
Also known as:
• Technical efficiency
• Producer efficiency
1 Producer’s output cannot be increased without increasing one or more input; producer is on a production function
• Scale efficiency
• Technological efficiency
2 Each producer is producing output at minimum average cost;
producer is at the bottom of its average cost curve
Economic efficiency Producer’s output cannot be increased without increasing cost;
producer is on its average cost curve
Operational efficiency
Allocative efficiency Also known as:
• Pareto efficiency
• Exchange efficiency
• Social efficiency
Commodities traded at prices where social marginal cost equals social marginal benefit. No person’s utility can be increased without reducing the utility of someone else. Demand equals supply; social costs equal private costs; social benefits equal private benefits
Operational efficiency Economic efficiency
Effectiveness
Effective health care does not necessarily imply efficiency. It simply means that production or consumption of something will yield satisfaction (or utility). Thus, effective health care is about improving health status. Both operational and allocative efficiency, however, are necessarily conditional upon effectiveness. An example of effectiveness would be a drug with a proven beneficial impact on a health condition. The focus is limited to the production of health gains.
Operational efficiency
Operational efficiency asks the question, ‘Given that some activity is worth doing, what is the best way of providing it?’ This perspective brings costs into the calculus alongside effectiveness. Operational efficiency involves the selection between alternative means of achieving the same ends and may, therefore, be interpreted as the pursuit of maximum output for a given level of resources or minimum cost for a given level of output.
An example of operational efficiency would be if there was a choice between an effective drug therapy and a surgical operation to treat a given condition. Assessment of the costs and effectiveness of each option determines which is the more operationally efficient. If drug therapy is both less costly and more effective then it is clearly to be preferred. The difficult judgement is if one treatment modality is both less costly and less effective than the other. In such a situation, the cost-effectiveness ratios of the alternatives determine which is most efficient; the lower ratio indicates greater operational efficiency.
The ‘rules’ for achieving operational efficiency are thus:
• If one means of achieving a given end is less (more) costly and produces the same amount of output then this option should (should not) be preferred;
• If one means of achieving a given end is less costly and produces more output then this should be preferred;
• If one means of achieving a given end is less costly and produces less output then cost-effectiveness ratios should be computed, the lower ratio indicating greater efficiency . . .
Allocative efficiency
Allocative efficiency judges whether an activity is worthwhile doing and, given that much health policy is about the scale at which programmes should operate, allocative efficiency may also address the question of scale, or as economists term it, marginal analysis. Just as operational efficiency infers effective health care, so allocative efficiency infers operational efficiency. If something is deemed worth doing then it must be carried out in a way which ensures the optimum use of scarce resources. The social perspective is fundamental to allocative efficiency. This perspective ensures that due account is taken of all costs and benefits of interventions, regardless of whether they fall within or outside the health care sector (e.g. on families and patients or on the productive capacity of the economy) . . . The rules of allocative efficiency capture the utilitarian ethic, the maximisation of satisfac- tion for the greatest number of individuals who collectively form society. It is important, however, to recognise the harm that over-zealous pursuit of allocative efficiency may lead to. It may create a pattern of resource and benefit distribution which discriminates against certain members of society; maximising health, or utility, from health care resources may not be conducive with a ‘fair’ distribution of health.
Feedback
1 Allocative efficiency describes a situation where resources are allocated and commod- ities distributed in a way that maximizes social welfare. Social welfare is total benefit minus total cost. For a particular market, social welfare is represented by the area below the marginal social benefit curve and above the marginal social cost curve. Social welfare is maximized at the point where marginal social benefit (MSB) equals marginal social cost (MSC). If MSB is greater than MSC then you can increase social welfare by increasing quantity because the extra benefit is greater than the extra cost. And vice versa: if MSB is less than MSC then you can increase social welfare by decreasing quantity because the benefit lost is less than the cost saved. A free market will be allocatively efficient if demand is equal to MSB and supply is equal to MSC. This will only be the case if there are no market failures.
2 It is a good thing for a market to be allocatively efficient because it means that total benefit to society is maximized. This means that the sum of the utilities of every person is maximized. However, this might mean that some people have a very large amount of utility but others have a relatively small amount. An allocatively efficient allocation might be considered to be unfair. In this case there is scope for government intervention even though there is efficiency. Equity is another objective of economics and is discussed in Chapter 12.