Equity and Need

© Allen C. Goodman, 2013

Remember the Trade-off Between Efficiency and Equity?

• They are not the same.

• We saw this in production.

• We’ll see this in consumption.

What’s the most cost-effective place?

• Thought experiment. Most cost effective place is where we get the highest mean score. Why?

10

10

30

20

Ed

Harry

45o

• We can draw a line with a slope of –1. This line gives us places with equal totals. Start with S = SE + SH = 10.

SE+SH=10

SE+SH=20

SE+SH= max

Mean = (0+10)/2 = 5

Mean = (8+8)/2 = 8

Mean = (20+0)/2 = 10

Highest mean!About 22/2

Let’s review Pareto Efficiency

Context of trade.

One can’t make oneself better off, without making someone else worse off.

We usually do this with an exchange Edgeworth Box.

Abner

Belinda

Abner’s Preferences

Belinda’s Preferences

Spam

L-Surg

Let’s review Pareto Efficiency

Start at Point A.

Is this an Equilibrium?

Abner

Belinda

No, they can trade (A trades spam; B trades surgery

Belinda can be better off.

ASo can Abner.

BL-Surg

Spam

LA

SA

SB

LB

Let’s review Pareto Efficiency

We can plot similar points, which we recognize as a “contract curve”

Abner

Belinda

And so on.

A

BL-Surg

Spam

Let’s review Pareto Efficiency

We must recognize that point X is Pareto Optimal.

Abner

Belinda

So is point Y.

A

B

is a place where you haveequity as defined by eachperson’s having the same amount of each good. Is this PO?

L-Surg

Spam

2

L

2

S

L

SX

Y

Utility Possibility Frontier

We can plot Abner’s utility against Belinda’s Utility.

It is monotonically decreasing. Why do we draw it this way?

Abner’s Utility

Be l

i nd

a’s

Uti

li ty

X´

Y´

What if we want a perfectly egalitarian society?

Does equal utility mean equal allocations?

What about a utility functionfavoring people like Belinda?

A Critique

• Fundamental Issue. How well does the model work?

• Recall that with Edgeworth Box, the 1st Welfare Theorem says that markets will always get us to a Pareto Optimal allocation.

Abner

Belinda

A

BL-Surg

Spam

Tom Rice argues:• Looks at several assumptions, including:

– Consumers have perfect information– Firms don’t have monopoly power– There are no externalities– Prices reflect resource scarcity

• One can argue numerous points– How bad is bad information. What about informed sources, care managers?– What causes monopoly power? Is it the market, or is it government actions?– In what way do externalities come in? Rice argues that lavishing resources

on the rich will create a negative externality of “envy” by the poor.– Insurance (through moral hazard) impacts relative prices.

• Also, you have equity questions

Thoughts

• Rice wants us to think good thoughts about national health insurance proposals, arguing that they can address efficiency and fairness considerations at least as well as markets.

• Ultimate issue: Economic theory tells us that at best the ideal market can tie an ideal government, not that it can do better.

• The reverse is also true.