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It is not enough for products to be produced at the lowest possible cost. The right products must also be produced if there is to be economic efficiency
Allocative efficiency is a situation where the current combination of goods produced and sold gives the maximum satisfaction for each consumer at their current levels of income.
Competitive firms are allocatively efficient
This means that they produce the goods and services that consumers most greatly desire to consume.
Allocative efficiency can also be achieved in a free market as firms will distribute goods and services to consumers in an optimal way.
Allocative efficiency in any activity is achieved where:
Marginal benefit equals Marginal cost
Marginal benefit is how much total benefits increase when one more unit of output is produced.
Marginal cost is how much total costs increase when one more unit of output is produced.