Chapter 5 - Efficiency and Equity

Question 1

CH5 The “big tradeoff”?

Answer 1

• is the tradeoff between Efficiency and Fairness.
• The idea : the Government redistributes income so that it is more equally shared, output decreases so that it is less than the efficient amount. Output shrinks because such redistribution BLUNTs people’s INCENTIVES to work.
  => redistributing income so that everyone has the same amount of income -> everyone’s incomes are smaller than if less redistribution is pursued

Question 2

CH5

1) What are the two views of fairness?
2) How does each view redistribution of income from the rich to the poor?

Answer 2

1) “it’s not fair if the result isn’t fair.” - Utilitarianism
= income should be redistributed from the rich to the poor in order to create a fair result.

2)”it’s not fair if the rules aren’t fair.” - equality of opportunity.
= private property may be transferred only under VOLUNTARY EXCHANGE, so redistribution of income is not fair unless it is voluntary.

Question 3

#CH5 What approach to fairness argues in favor of government policies that redistribute income so that
there is more equality of income?

Answer 3

– “FAIR RESULTS” approach that argues “it isn’t fair unless the results are fair.” –
= Utilitarianism - a society should strive for “the greatest happiness for the greatest number of people.”
Utilitarians argued that COMPLETE EQUALITY of income was the only income distribution that met their requirement
=>they asserted that government policies to redistribute income are necessary for fairness.

Question 4

#CH5 Why does the problem of the big tradeoff arise when the government engages in the process of
redistributing income using taxes and transfers?

Answer 4

-2 reasons-
1) In the process of transferring income
from the people who have to those who do not have, an administrative cost is incurred by society. The result is that $1 taxed is not $1 transferred.
=> the effort to make incomes more equal decreases the
average income.

2) Taxing people’s INCOME is a disincentive to WORK, while taxing people’s SAVINGS is a disincentive to accumulate CAPITAL. –> people work less and save less, both of which decrease the quantity of goods and services produced and decrease people’s income.
=> the effort to make incomes more equal decreases the average income.

Question 5

CH5 What are the four types of markets?

Answer 5

1- Perfect competition has MANY FIRMS selling IDENTICAL products to many buyers, with NO barriers to entry
or exit.
2- Monopolistic competition has MANY FIRMS making similar but not identical products with no barriers to
entry or exit.
3- Oligopoly has a SMALL NUMBER of generally large firms producing either identical or DIFFERENTIATED
products.
4- Monopoly has ONE firm selling a good with no close substitutes and a barrier that BLOCKS the entry of new
firms.

Question 6

CH5 The four-firm concentration ratio

Answer 6

_ the percentage of value of sales
_ A low FFCR -> a high degree of competition (<60)
A high FFCR -> an absence of competition (>60)

Question 7

CH5 The HHI

Answer 7

_ the square of the percentage market share
_ HHI < 1500 -> being competitive (monopolistic)
1500< HHI < 2500 -> moderately competitive
HHI > 2500 -> uncompetitive ( oligopoly), not very competitive

Question 8

CH5 Market Structure

Answer 8

Concentration ratio :0 -Perfect competition
Low- Monopolistic competition
High- Oligopoly
100- Monopoly
HHI :Close to 0 -Perfect competition
Less than 2,500 - Monopolistic competition
More than 2,500 - Oligopoly
10,000- Monopoly

Question 9

CH5 How would a merger between Coca-Cola and Pepsi Cola affect the FFCR for the soft drink market? How would it affect the HHI for the soft drink market?

Answer 9

Both Coca-Cola and Pepsi Cola are among the four largest firms in the soft drink market, so a merger between the two firms would (drastically) raise FFCR and (drastically) raise HHI

Question 10

CH5 • John Rawls

Answer 10

make the poorest as well off as possible

• maxi-min principle

Question 11

CH5 Robert Nozick

Answer 11

symmetry principle-people in similar situations are
treated similarly
property rights and contract law

Question 12

CH5 8 Allocation Methods

Answer 12

Command and control
• Majority rule
• First come, first served
• Market price
• Lottery
• Personal characteristics
• Contest
Force

Question 13

CH5 According to John Rawls’ modified utilitarianism, income should be redistributed until

Answer 13

the poorest person is as well off as possible, after incorporating the costs of income transfers.