Efficiency and Equity

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  • Created by: Clodagh
  • Created on: 24-04-14 20:48
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  • Efficiency and Equity
    • Economic Efficiency
      • This concerns the relationship between the inputs to the production process (land, labour, capital, enterprise) and the output they produce
      • This concept relates to the basic economic problem of scarce resources and infinite wants and needs
    • Technical Efficiency
      • This involves producing a given quantity at the lowest possible average cost
      • All points on the long run average cost curve are technically efficient
        • The LRAC represents a boundary between those output/cost combinations which are attainable and those which are not
    • X-inefficiency
      • This is the most common name for technical inefficiency
      • X-inefficinecy occurs when there is waste in the production process
        • Average costs for producing a given level of output is higher than it needs to be
      • All points above the LRAC exhibit x-inefficiency
      • Why?
        • Weaknesses in the organisation of production and management
        • Lack of competition, allowing firms to survive without striving to reduce costs
        • A lack of profit motive (especially for state owned firms)
    • Productive Efficiency
      • Productive efficiency entails producing goods and services at the lowest possible average cost for any level of output
      • This type of efficiency is achieved when the average cost curve is at its bottom point and implies that all available internal economies of scale are being exploited
    • Minimum Efficient Scale
      • The MES of production is the smallest scale of production that allows the exploitation of all internal economies of scale and hence production at the lowest possible average cost
    • Allocative Efficiency
      • This is achieved when society derives the most possible utility from its scarce resources
      • The concepts of technical and productive efficiency are not related to whether people gain utility from the goods and services produced
      • Cost Benefit Principle
        • It's worthwhile allocating resources to producing an extra unit of a good if the marginal benefit of doing so exceeds the marginal cost
        • The price that a consumer is willing to pay for a good is a measure of the benefit or utility that they receive from it
      • Externalities
        • Social benefit = private benefit + external benefit
        • Social cost = private cost + external cost
        • When there are no externalities associated with the good, social and private costs and benefits are one and the same thing
          • When there are externalities, the condition for allocative efficiency must be amended
        • Externalities are third party effects not accounted for in market prices
        • When externalities are present, allocative efficiency is achieved when MSB = MSC
    • Static vs. Dynamic Efficiency
      • Allocative, technical and productive efficiency are static concepts, concerned with efficiency at a specific point in time
      • Dynamic efficiency is concerned with the future
    • Equity
      • Equity can be understood to mean fairness
        • In contrast to efficiency, it is a concept that belongs to normative economics
      • Market performance is typically evaluated both from a positive perspective of efficiency and a mormative perspective of equity
      • Horizontal Equity
        • This is concerned with the fair treatment of people whose circumstances are the same
          • For example, the idea that people with a similar ability to pay taxes should pay the same or similar amounts
      • Vertical Equity
        • This related to the fair treatment of people whose circumstances differ
          • For example, the idea that people with a greater ability to pay taxes should pay more
    • Trade-off
      • Measures that reduce inequality may enhance equity but also blunt economic incentives and cause inefficiency

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