Concept of Equity & Efficiency in Economics

Concept of Equity in Economics

Let’s first begin by understanding the concept of equity in economics. By equity, we mean fairness or justice in distribution. ‘Equity’ is different from ‘equality’.

In Public Finance, when we talk about equity, our focus is mainly on deciding among alternative economic policies and choosing the one which helps in achieving maximum equity in distribution. This ‘distribution’ may be of income, wealth, tax burden, expenditure or utility etc. Depending upon distribution, a policy may be termed as desirable or undesirable.

Horizontal & Vertical Equity

Equity can be horizontal or vertical. Horizontal equity implies fairness or justice in the treatment of individuals who are in similar circumstances. For example, if we suggest that people at the same level of income should pay the same amount of tax, that will be an example of horizontal equity.

On the other hand, vertical equity implies fairness or justice in the treatment of individuals who are in different circumstances. So, a government policy initiative of taxing rich people and subsidising the poor will be a move towards vertical equity.

Another type of equity is ‘intergenerational equity’, where the effect of policy is seen on present as well as future generations.

For example, if the government chooses to borrow heavily today to finance its expenditure, it will imply heavy interest liability on future generations apart from the need for higher taxes to pay back the borrowed amount (debt), so it becomes extremely important to monitor the use of borrowed funds (must be productive) and to monitor the choice between debt and tax, in the present period.

Definition of Efficiency in Public Economics

Samuelson’s Modified Pareto Efficiency Criteria

As explained previous article ‘Problem of allocating Resources- Private and Public mechanism for allocating resources in General Equilibrium analysis’, we know that Samuelson’s General Equilibrium Model is based on two goods (a public and a private good) and two people, Mr. A and Mr. B.

His analysis is based on the assumptions that there are two goods in the economy, one private good P and one social good S. Production possibility curve for two goods P and S is given. Production possibility curve (PPC), also called as transformation function or production frontier shows the possibilities open for increasing the output of one good by reducing the output of other. Further, Tastes of the consumers are given i.e., we have utility map of Mr. A as well as Mr. B.

To show efficient allocation of a social good in general equilibrium framework, first we select a given level of utility for individual A which is depicted by his indifference curve ICA. Subtracting it vertically from the transformation curve, we get another curve known as residual curve or consumption curve for B. This consumption curve will reveal the maximum private good available for B, given A’s utility level.

Out of various options of private good available for B, B will choose that point where residual curve touches its highest Indifference curve. In the figure ICB2 is that indifference curve and E is the equilibrium for B. Corresponding to E, Mr. A will choose a point like K on his Indifference curve as point of consumption, K being exactly vertical to E. It is important to note here that both A as well as B will be consuming same amount of public good, which can be found. In case of private good, it will not be so.

Read More in: Theory of Public Finance

1. Public Finance: Meaning, Nature & Scope
2. Role of Government in Economy
3. Role of Government in Mixed Economy: Public & Private Sector
4. Role of Government under Cooperation and Competition
5. Role of Government in Economic Development and Planning
6. Concept of Public Goods, Private Goods, and Merit Goods
7. Concept of Market Failure and Functions of Government
8. Market Failure and Functions of Government: Decreasing Costs
9. Market Failure and Functions of Government: Externalities
10. Market Failure and Functions of Government: Public Goods
11. Future Market: Meaning, Role & Uncertainty
12. Concept of Information Asymmetry
13. Theory of Second Best: Concept & Explanation
14. Problem of Allocation of Resources: Public & Private Mechanisms
15. Preferences: Meaning, Types & Problems of Preference Revelation
16. Preference Aggregation & Its Mechanism
17. Voting Systems, Direct Democracy, Representative Democracy, Leviathan Hypothesis & Arrow’s Impossibility Theorem
18. Economic Theory of Democracy: Concept & Explanation
19. Politico Eco Bureaucracy: Concept & Explanation
20. Rent-Seeking and Directly Unproductive Profit-Seeking Activities
21. Rationale for Public Goods: Concept & Explanation
22. Benefit Theory or Voluntary Exchange Theory
23. Lindahl Model: Concept, Equilibrium & Limitations
24. Bowen Model: Concept, Advantages & Limitations
25. Samuelson’s Model of Public Expenditure
26. Musgrave’s Model of Public Expenditures
27. Demand Revealing Schemes for Public Goods
28. Vickery-Clarke-Groves Mechanism
29. Groves-Ledyard Mechanism
30. Tiebout Model: Concept, Assumptions Equilibrium & Simple Tiebout Model
31. Theory of Club Goods
32. Keynesian Principles of Stabilization Policy
33. Difference Between Keynesian Economic Thought and Others
34. Role of Expectations and Uncertainty in Formulating Stabilization Policy
35. Intertemporal Markets Efficiency & Failure
36. Liquidity Preference Theory
37. Diamond-Dybvig Banking Model
38. Preference Shocks, Adverse Selection & Central Bank
39. Equilibrium Deposit Contract
40. Social Goods and Its Effect on Stabilization Policy
41. Effect of Infrastructural Facilities on Stabilization Policy
42. Effect of Distributional Inequality on Stabilization Policy
43. Effect of Regional Imbalances on Stabilization Policy
44. Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism
45. Peacock-Wiseman Hypothesis: Explanation, Graph & Criticism
46. Public Expenditure: Concept, Objectives, & Public vs Private Expenditure
47. Pure Theory of Public Expenditure
48. Structure & Growth of Public Expenditure in India
49. Trends, Lessons & Priorities in Public Expenditure in India
50. Social Cost-Benefit Analysis: Project Evaluation, Estimation of Costs & Discount Rate
51. Performance Based Budgeting and Zero Based Budgeting
52. Theories of Tax Incidence: Concentration Theory, Diffusion Theory & Modern Theory
53. Tax System and Its Principles
54. Equity Principle and Efficiency Principle of Taxation: Meaning, Explanation & Examples
55. Ability to Pay and Benefits Received Principle of Taxation
56. Theory of Optimal Taxation: Excess Burden & Distortions of Taxation
57. Deadweight Loss of Taxation: Causes, Measurement & Example
58. Concept of Equity & Efficiency in Economics
59. Trade-Off Between Equity and Efficiency: Meaning & Example
60. Theory of Measurement of Dead Weight Loss
61. Double Taxation: Meaning, Desirability, Forms & Solution
62. Solution to Problem of Double Taxation: Intra-Country & International
63. Double Taxation Avoidance Agreement (DTAA) and Indian Policy
64. Classical View on Public Debt
65. Compensatory Aspect of Public Debt Policy
66. Public Debt or Borrowings: Concept, Need, Sources & Types
67. Concept of Public Debt or Public Borrowings
68. Need for Public Debt or Public Borrowing
69. Sources of Public Debt
70. Classification of Public Debt
71. Burden of Public Debt: Meaning, Types & Explanation
72. Debt Through Created Money or Deficit Financing
73. Public Debt (Public Borrowings) and Inflation (Price Level)
74. Crowding Out of Private Investment and Activity
75. Principle of Public Debt Management and Debt Repayment