Wednesday, June 27, 2018

Economist Dilemma Between Efficiency and Equity

What is economic efficiency?
Resources are finite or scarce. In fact, many of them are irreplaceable or non-renewable. Once they deplete, they will be gone for good. Therefore, there is an urge by policymakers and economists to utilise these resources in the best possible way to ensure that wastages can be avoided or at least minimised

To achieve efficiency (although this may be very difficult), we must ensure that the highest level of output is being produced from a given amount of input, and eventually, the final output must be in the best interest of society or individuals. The first condition is known as productive efficiency. If it is achieved, costs of production would be at its lowest. The second part of the definition refers to allocative efficiency. In order for efficiency to take place, both conditions must be present. Resources are still wasted if only either one condition is attained. For instance, a car company may brag about its ability to lower the costs of production over the years. However, if it finds great difficulty in selling them off each time, then it would be equivalent to resources wasted. Factors of production like land, labour and capital that went into making those cars could have been utilised elsewhere more meaningfully

It is also worth noting that once efficiency is fully attained, an economy would be operating along the boundary of its PPC. Society's welfare is said to have been maximised (hence the condition of MSB = MSC, which is also known as social efficiency). It is impossible to further increase social welfare. No one can be made better-off without making another person worse-off, and hence the condition of Pareto efficiency

What is equity?
Equity is concerned with the final outcome and it can only happen when the result is the same or fair for everyone

In practice, it can be quite difficult to achieve both simultaneously:
a. An increase in income tax rates will reduce the incentive to work hard. In other words, it causes inefficiency. However, equity may increase because of the benefits pay out

b. A poll tax (a levy that a voter has to pay in order to be able to cast a vote) can be considered as efficient as it doesn't reduce the incentive to work. However, it can be considered as inequitable as the rich pay the same amount as the poor

c. An indirect tax onto cigarettes obviously improves the allocation of resources. Production and consumption of a demerit good are reduced to a socially optimal/ desirable/ efficient level. However, the outcome may not be entirely fair to low-income smokers who happen to be the group that finds it hardest to quit the habit. There will be a regressive effect as they now have to spend a bigger portion of their disposable income to purchase cigarettes

d. Bailing out troubled banks is morally wrong. However, that seems to be the most sensible action to take especially when there is a major financial crisis. If major banks collapse, so is the entire economy. There are costs in doing so e.g. higher taxes, poorer credit rating, rise in budget deficit and national debt and many more. However, the economic benefits are perceived to be far greater e.g. preventing other firms from going bankrupt, save tens of millions of jobs, avoiding capital flight, preventing value of currency from nose-diving, lowering the number of poverty cases and many more. Having said so, some will not be happy. Their marginal tax rates may be adjusted upward, fewer low income/ jobless people qualify for benefits and spending onto healthcare and education per capita will decrease. This is inequitable

e. Construction of new roads may improve overall economic efficiency/ well-being. However, not everyone will be equally pleased e.g. affected families, evacuated firms and environmental activists

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