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8.2 Efficiency and Equity

There is a subfield of economics called “welfare economicsA subfield of economics that focuses on evaluating the performance of markets.” that focuses on evaluating the performance of markets. Two of the criteria used to assess markets are efficiency and equity.

Efficiency is a shortened reference to what economists call Pareto efficiencyThe outcome of a set of exchanges between decision-making units in a market or network of markets when it is impossible to modify how the exchanges occurred to make one party better off without making another party worse off; also known as efficiency.. The outcome of a set of exchanges between decision-making units in a market or network of markets is called Pareto efficient if it would be impossible to modify how the exchanges occurred to make one party better off without making another party decidedly worse off. If there is a way to change the exchanges or conditions of the exchanges so that every party is at least as satisfied and there is at least one party that is more satisfied, the existing collection of exchanges is not Pareto efficient.

Pure Pareto efficiency is an ideal rather than a condition that is possible in the complex world in which we live. Still, in clear cases where some intervention in the market can result in significant overall improvement in the pattern of exchanges, regulation merits consideration.

One circumstance where this notion of efficiency is not fulfilled is when there is waste of resources that could have some productive value. When markets leave the useful resources stranded to spoil or be underutilized, there is probably a way to reconfigure exchanges to create improvement for some and at a loss to no one.

In the case of monopoly, which we examined in Chapter 7 "Firm Competition and Market Structure", the price and quantity selected by the monopolist is not efficient because it would be possible, at least in principle, to require the monopolist to set the price at the perfect competition equilibrium, reclaim the deadweight loss in consumer surplus and producer surplus, and redistribute enough of the surplus so the monopolist is as well off as it was at the monopoly price and the consumers are better off.

EquityThe issue of whether the distribution of goods and services to individuals and the profits to firms are fair. corresponds to the issue of whether the distribution of goods and services to individuals and the profits to firms are fair. Unfortunately, there is no simple single principle, like Pareto efficiency, that has been adopted as the primary standard for equity. Although there is general support for the idea that the distribution of goods and services ought to favor those with greater talents or those who work harder, there are also those who view access to basic goods and services as reasonable expectations of all citizens. Despite the impossibility of developing a general consensus on what constitutes equity, when enough people become concerned that the distribution of goods and services is too inequitable, there are likely to be pressures on those in political power or political unrest.

Most microeconomists tend to view active regulation of individual markets as worthy of consideration when there are inefficiencies in the functioning of those markets. Since managerial economics (and this text) has a microeconomics focus, we will address the merit of market regulation from this perspective as well.

Problems of inequity are usually regarded as a problem of macroeconomics, best handled by wealth transfers, such as income taxes and welfare payments rather than intervention in the markets for goods and services. Still, there are instances where regulatory actions directed at specific markets reflect equity concerns, such as requiring companies to offer basic services at lifeline rates for low-income customers.