Efficiency and Equity pt 2

Question 1

What alternatives are available when a market is inefficient?

Answer 1

• Majority rule
• Command good within firms
• First come first serve good at an ATM

Question 2

What are the two schools of thought regarding fairness?

Answer 2

• Its not fair if the result isn’t fair

- Its not fair if the rules aren’t fair

Question 3

What does ‘Its not fair if the result isn’t fair’ mean?

Answer 3

It is unfair if people’s outcomes are too unequal.

Question 4

What is utilitarianism?

Answer 4

The 19th Century idea that only equality brings efficiency. Utilitarianism is a principle that states that we should strive to achieve “the greatest happiness for the greatest number”.

Question 5

What do utilitarians believe?

Answer 5

That income from the rich must be transferred to the poor, up to the point of complete equality where there are no rich and no poor.

Question 6

Why do utilitarians believe what they believe?

Answer 6

• Everyone has the same basic needs
• The greater the person’s income, the smaller their marginal benefit of a dollar
• The millionth dollar spent by a rich person brings a smaller marginal benefit than the thousandth dollar spent by a poor person

Question 7

What is the big tradeoff in terms of equality?

Answer 7

• The ideal of complete equality ignores the costs of making income transfers
• Recognising the costs of making income transfers lead to what is called the big trade off between efficiency and fairness

Question 8

What facts is the big trade off based on?

Answer 8

• Taxing the rich is the only way to transfer income to the poor
• Taxing income = people work less
• Q of labour is less than efficient Q
• Taxing capital makes people save less
• Q of capital less than efficient Q
• Smaller Qs of labour and capital = Q of goods produced less than efficient Q
  ECONOMIC PIE SHRINKS

Question 9

How do transaction costs lead to inefficiency in terms of taking money from rich people and giving it to poor people?

Answer 9

• Some of the $ spent on administration tax
• Cost of tax collecting agencies
• Taxpayer must hire accountant, auditors and lawyers so they pay correct sum
• Usage of skilled labour that could be better utilised elsewhere

Question 10

How can we make the poorest as well off as possible?

Answer 10

Taking the costs of income transfers into account through tax after paying costs associated with transfer and what is left transferred to the poor

Question 11

How high should the taxers be?

Answer 11

They should not be so high that they make the economic pie shrink to the point at which the poorest person ends up with a smaller piece because a big share of a small pie can be less than a small piece of a big pie

Question 12

What is the ‘It’s not fair if the rules aren’t fair’ school of thought?

Answer 12

Based on the symmetry principle - people in similar situations should be treated similarly, based on rules which apply to everyone so they can use their skills and resources to create things that are valued by someone

Question 13

What rules is the ‘Its not fair if the rules aren’t fair’ principle based on?

Answer 13

1) The state must enforce laws that establish and protect private property
2) Private property may be transferred from one person to another by voluntary exchange

Question 14

How are the two rules enforced in practice?

Answer 14

• Everything that is valuable must be owned by individuals and protected from theft
• The only legitimate way to acquire property is to buy it in exchange for something else

Question 15

How do fair rules relate to efficiency?

Answer 15

• Resources will be allocated efficiently if property rights are enforced and voluntary exchange takes place
• It isn’t possible for everyone to have high incomes