Equity Flashcards
Efficiency VS Equity
Condition in which nobody can be made better off without making somebody else worse off
Equity: Resources are distributed fairly among members of society but total number may decrease, causing someone to be made worse off to make another better off
State intervention (E.g. Taxes) and their trade-offs
Taxes
Trade-offs
1) Changes in incentives to work/save/consume
2) Transactions costs
3) Monitoring costs
4) Enforcement costs
How much efficiency are we willing to give up to reduce inequality?
Measure relative value of a reduction in inequality compared to a loss in efficiency using the Social Welfare Function
Social Welfare Function
Social Welfare Function provides the basis for ranking different allocation of resources as it maps and aggregates individual utilities into an overall function. It gives the level of social welfare corresponding to a particular set of levels of utility attained by members of society.
Utility is the same for every point along the curve, except curve 3 has higher utility than the other curves.
Social indifference curve
If individual indifference curves give the level of social welfare corresponding to a particular combination of goods, social Indifference curve gives the combinations of individual utility between which society is indifferent, leading to equal levels of welfare for society.
The axis represents utility but how do we measure utility in real life?
Philosophical theories to interpret social welfare functions
1) Utilitarian (or Benthamite) Approach: maximise the sum of the utility of its members (sum of x+y)
The utility of all individuals is given equal weight
2) Rawlsian Approach (opp to Benthamite)
However, there is no meaningful numerical way to measure individual utility or compare the utility of individuals. Whose preferences does the social welfare function represent?
Stiglitz’s logic
Efficiency VS Equity trade-off occurs when a project is not a Pareto improvement, results in an increase in efficiency (sum of individual gains and losses lead to positive gains) but some measure of equity is decreasing OR when the project is not a Pareto improvement, results in a decrease in efficiency but some measure of equity is increasing.
Ordinary demand curve
Quantity of goods that an individual will buy increases as the price decreases due to the income and substitution effects:
a) Income effects - Consumers now have a higher ability to pay as their real income increases
b) Substitution effects - When normal goods become relatively cheaper compared to their substitutes, whose prices remain unchanged, consumers tend to consume more to maximise utility so quantity demanded increases.
Less steep compared to compensated demand curves because it includes both effects
Compensated demand curve
Ordinary Demand Curve without the Income effect
Normal goods = +Subst Effect - Income effect
Substitution Effect: If the price of normal goods decreases, consumers tend to buy more of them. This is because normal goods become relatively cheaper compared to their substitutes, whose prices remain unchanged.
Income Effect: A reduction in the price of normal goods leads to an increase in both real income and the quantity purchased. This suggests that both the substitution effect and the income effect for normal goods are aligned in the same direction.
However, Inferior goods = +Subst Effect -Income Effect
Substitution Effect: As the price of Inferior Goods declines, their demand rises. This is due to the fact that Inferior Goods become relatively more affordable compared to their substitutes. a positive substitution effect contributes to an upswing in consumption.
Income Effect: A reduction in the price of Inferior Goods leads to an increase in real income. However, this results in a decreased demand for Inferior Goods, as consumers shift towards superior alternatives.
Operationalising gains, losses and efficiency impacts of a project
1) Compensation Principle: If the aggregate willingness to pay exceeds the cost the project is ok
2) Trade-offs across measures: How does the project impact different groups?
3) Weighted Net Benefits: assign weights to the net gains of different groups and summarise the impacts in a single number (who benefits, who should benefit?)
Idea is that even if it is not a pareto improvement, if there is overall positive gains, improvement in utility, and efficiency, we can go ahead and implement the project.
Poverty VS. Inequality
Poverty: Inability to maintain an acceptable living standard
- Absolute poverty: Comparative measure between countries
- Relative poverty: Measure within country
Inequality: Unequal distribution of economic resources
