CU-Boulder ECON 4545 - Equity and Efficiency Defined and Considered

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Economists define screwed up to mean the allocation of resources is either inefficient, inequitable or both.According to economists, an allocation of resources is efficient if it impossible to change the allocation so as to make one or more members of society better off without making any other members worse off.An important question is how one might decide whether one inefficient allocation is more efficient than another inefficient allocation.Some review questions: With the definition of efficiency in mind, answer the following question.If the “unregulated market” is causing the inefficiency, we say that the market is failing, and call what is happening a market failure.Some of the concerns about environmental and natural resources are equity based, some are efficiency based, and some are both.Consider how one might represent graphically efficiency and inefficiency.Equity and Efficiency defined and considered – Edward R. Morey - 09/08/14 Equity and efficiency defined and considered Edward R. MoreyEfficiencyequity.pdf September 3, 2014 You might want to study my Econ 4999 notes “Efficiency is like “good” sex: more is better, except when it’s not” People are concerned about natural and environmental resources because they feel these resources are not being correctly allocated. That is, they think that the natural resource sector of the economy is screwed up. Reasons usually fall into one of two categories: The market is at fault and more government control is needed, or The government is at fault and less government intervention is called for. Screwed up is a nice expression, but we need to be more precise.Equity and Efficiency defined and considered – Edward R. Morey - 09/08/14 Economists define screwed up to mean the allocation of resources is either inefficient, inequitable or both. (Sometimes people include not sustainable as another form of screwed up; economists typically don’t include it–an economist would say that under certain circumstances, sustainable is not efficient). Equitable means fair. What is fair is a normative issue. There is no right or wrong answer from an economic perspective. Opinions can differ. Fair does not necessarily mean equal Assume we all agree on who is and who is not a member of society—this is critical According to economists, an allocation of resources is efficient if it impossible to change the allocation so as to make one or more members of society better off without making any other members worse off. Consider the converse, if an allocation of resources is inefficient, there is the potential for a free lunch: it is possible to reallocate resources in a way that makes some better off and no one worse off. When an allocation is efficient, there is no longer this potential. Efficiency sounds like a good thing – who wouldn’t want a free lunch? There can be an infinite number of allocations that are efficient. Draw a utility frontier for two individuals.Equity and Efficiency defined and considered – Edward R. Morey - 09/08/14 Allocations are either efficient or inefficient, and most, in the real world, are inefficient. My experience is that most, but not all, undergraduate economics majors can recite the above definition, but have only a vague notion of what it means. Make sure you understand.Equity and Efficiency defined and considered – Edward R. Morey - 09/08/14 An important question is how one might decide whether one inefficient allocation is more efficient than another inefficient allocation. I am not sure all economists would agree on how to do this, some might say efficiency is like pregnancy: “one is, or one is not …, and there ain’t no in-between.” Consider two allocations of resources: allocation A with lots of steaks and flat-screen TVs and allocation B with less of that stuff but with more parks and cleaner air. Shifting from B to A (towards more steaks and TVs) would make some individuals better off and some worse off. Now consider how much those who would be better off would pay, in the common unit of exchange, to shift from B to A, and then consider how much the losers would be willing to pay to stop the shift. If the gain to the gainers, in terms of the units of exchange, is greater than the loss to the losers, one might define allocation A as more efficient than allocation B.1 We will use this as a simple definition of efficiency increasing.2 Not that changes that make some better off without making any others worse are efficiency increasing. Economists like these kinds of changes (think they are “good” and “right”).3 1 This definition of efficiency increasing is not without its problems. For example, by this definition if one starts at B one might conclude that A is more efficient than B, but if one starts at A conclude that B is more efficient than A. 2 There are some problems with this definition of efficiency increasing. For example, one can create examples where if at B going from B to A is efficiency increasing, but if at A going from A to B is efficiency increasing.Equity and Efficiency defined and considered – Edward R. Morey - 09/08/14 Changes that make some members of society better off and no members worse off are deemed Pareto Improvements Vilfredo Pareto (1848-1923)4 3 Note that a change that makes some better off without making any others worse off is sufficient for the change to be efficiency increasing, but it is not necessary. 4 Pareto, a father of welfare economics, eventually became disillusioned with economics and gave it up for sociology.Equity and Efficiency defined and considered – Edward R. Morey - 09/08/14 Economists typically like market transactions because they are often Pareto Improvements. If I buy a head of organic broccoli for $6.50 at Whole Foods, according to economists, I am better off (I would not have voluntarily made myself worse off) and Whole Foods is better off (otherwise they would not have voluntarily sold it for $6.50). And, no one else is worse off, so the new allocation is more efficient than the old allocation. In addition, the exchange is a Pareto Improvement. Things are not so simple if I buy, instead, cigarettes, bullets or gas: in those cases, individuals other than the exchangers might be negatively, or positively, affected.5 An interesting question is whether trades for certain commodities should, or should not be allowed. Economists generally like market transactions when


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CU-Boulder ECON 4545 - Equity and Efficiency Defined and Considered

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