Exchange Efficiency
A second condition necessary for an economy to be economically efficient is exchange efficiency, which exists when there are no mutually advantageous trades possible. If there is a possible trade that would benefit one transactor and in no way harm the other, then further improvement is possible and the original situation is not economically efficient. Further trade would increase value people perceive, and thus increase economic efficiency.
Like production efficiency, exchange efficiency requires that an equimarginal condition be met. The relative values (or marginal utilities) must have the same ratios for all people. The table below shows a case in which this condition is not met. Smith considers widgets twice as valuable as getwids, while Jones considers them three times as valuable. If Smith gives up one widget to Jones in exchange for two getwids, Smith will neither be harmed nor helped. The loss of the widget will be offset by the gain of two getwids. Jones, however, will consider himself better off. The loss of two getwids is of less value to her than the gain of one widget (since she considers widgets three times as valuable as getwids). Hence the initial distribution of goods was not exchange efficient. Trading yielded another distribution that the people considered more valuable. Only when the ratio of values is the same for all individuals will mutually advantageous trade be impossible.
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Value of another widget |
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Value of another getwid |
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If we replaced getwids and widgets with food and heroin in the table, the conclusions of the previous paragraph would have been the same. Though many people have objections to other people using heroin, economic efficiency assumes that all goals are equal--there are no goals better than others or worse than others. If one rejects this assumption, one may not always consider a move toward economic efficiency desirable. Apparently, the public in the United States does not believe that all goals are equal, because the law attempts to prevent exchange of heroin, and hence is an impediment to economic efficiency.1
There are many possible distributions of goods that are exchange efficient. It would be exchange efficient for Jones to have everything and Smith nothing. (Jones may in fact be uncomfortable with this division and give something to Smith, but this possibility is not shown in the way the table is constructed.) Economic efficiency says nothing about fairness or equity.
A final component of economic efficiency is product-mix efficiency.
1However, one can make a strong case that the use of heroin by one person can affect others who are in no way involved in the transaction. If this argument of an external effect has merit, restriction of exchange in heroin may not violate economic efficiency, and in fact may make the economy more efficient. This possibility is called an externality.