Economic efficiency

Efficiency is normally defined as a ratio of the quantity of some measure of output to the quantity of input required to bring it about. In economic theory, the desired output of economic activity is taken to be an increase in individual welfare, and the input required is some combination of the productive resources of land, labour and capital. The economic efficiency of an activity is thus taken refer to the resources required to generate a notional unit increase in welfare, and the term efficient is used to denote the ideal state of affairs in which an activity is optimum in that respect.

The concept of economic efficiency is central to the theorems of welfare economics and to the practice of cost/benefit analysis

Definitions of efficiency

Pareto efficiency

It is conceptually impossible to quantify the increase in welfare resulting from an activity, but it is possible in principle to determine whether it increases or decreases economic welfare. The conceptual barrier can thus be overcome by taking an efficient state of affairs to be one from in which nobody could be made better off in terms of welfare, without making someone else worse off. That state of affairs is termed Pareto efficient or Pareto optimum in honour of the economist, Vilfredo Pareto, who first put that definition forward.