Economic efficiency and equity
Economics is the study of how scarce resources are allocated; that is how a society answers the questions what, how and for whom? The objectives of equity and efficiency can help us judge how well we are managing to answer these questions.
Economic efficiency looks at whether we could, as a society, produce more or make some people better off without making others worse off . If this is the case, then we are not economically efficient. This concept can be illustrated by the production possibility frontier. In the diagram below, the point inside the ppf is economically inefficient. We could produce more apples and more pears, therefore making some people better off and nobody worse off. All points on the ppf itself will therefore be economically efficient.
Economic efficiency requires the following conditions to be met:
- Efficiency in production - productive efficiency requires firms to be producing goods at the minimum possible level of cost.
- Efficiency in consumption - this means consumers spending their money as efficiently as possible to maximise the utility (satisfaction) they get from their limited incomes
- Efficiency in specialisation and exchange
The last two of these are collectively known as allocative efficiency. Allocative efficiency occurs when consumers are gaining the maximum possible satisfaction at their current level of income.
Equity is another objective that may be pursued by governments and economic policy makers. Equity is a situation when income is distributed in a way that we could consider to be fair or just. This is NOT the same as an equal distribution of income. Equity is possible when income is unevenly distributed, so long as this distribution is considered fair and just. The problem is that people and governments will differ significantly on what they consider to be fair. A more laissez-faire government is likely to consider a more unequal distribution of income to be fair, while a more socialist government will want a more equal distribution of income as their objective.
Economic efficiency does not in itself lead to greater equity, indeed there may be conflicts between these objectives.
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