EQUITY and EFFICIENCY

By the end of this topic you will be able to
 Distinguish
between equity and equality
 Explain why the free market solution is not always
equitable
 Identify ways they government can achieve equity for
the state
 Discuss equity efficiency trade-off
Equity – Fairness or Equality - Equal



Each round you will be sorting block into colours
from their containers.
You will gain $1 for every 5 blocks you sort. Each
dollar can be exchanged for jelly beans.
You will have 5mins to sort through the blocks for
each round.
Equality = Equal or the same

Based on the fact that
 Different
people have the same level of economic resources
and income available to them.

Having absolute equality of income would mean that one
persons income would be exactly the same as another
persons income.
Equality = Same



Incomes (and wealth) are equal or unequal for
varying reasons
The state can alter the market distribution of income
and wealth to make it more equal if it believes the
market outcome is unfair
Equality = A measure of how equal people are in
terms of income distribution or opportunities.
Equity = Fairness

Horizontal Equity



Equal treatment of the equal
E.g. Those on equal incomes pay the same amount of tax
Vertical Equity



Unequal treatment of the unequal
E.g. Those on higher incomes pay more on their income taxes on the
basis that they can afford more
But what someone thinks is fair is based on a persons
 Values
 Political learning's
 Culture
EQUITY = Fairness


Outcomes may be equitable or inequitable
depending on our opinion.
Many see market outcomes as being inequitable.
The government’s role is to make adjustments to the
market to ensure that outcomes are more equitable.
Efficiency and Equity



When an economy achieves allocative efficiency it may not
represent an equitable outcome for people.
Some people are on very low incomes whose standard of
incomes are below what is considered fair.
An equitable situation would be where every New Zealander
has access to adequate health care, education and housing,
and a reasonable standard of living.
Equity and Equality



Even if there were complete equality of income this would not
be considered equitable because it would not reflect the
efforts or abilities of the individual.
Would it be fair that regardless of how hard you worked or
applied yourself the outcomes were the same?
Why work hard and stay in school if you are likely to be as
well off as a person who drops out of school at the age of 14?
Equity and Equality



Higher incomes earned by some people provide an
incentive to strive and recognise that differences do
exist between people.
Equity is achieved where equality of income
distribution is fair.
Inequality is a justification for the government to
intervene.
Equity Vs Efficiency




A market economic system leads to income inequality.
Those who own resources that are highly demanded yet in
short supply will be earning very high incomes.
Those who have very few resources that are demanded by the
market will have very low levels of income.
Market outcomes are unequal
What is an equitable distribution of income?

Choice depends on economic and political factors
 1.
Accepting market outcomes
 Would
not be tolerated for long. Most NZlanders are
concerned about fellow citizens. . New Zealanders believe
all people should get what they need.
What is an equitable distribution of income?

2. Accepting market outcomes but ensuring equity of
opportunity.


Provided we all have an equal chance to begin with we should
allow those who succeed to enjoy the fruits of their success.
3. Reducing Inequalities with progressive taxation and
transfers

Redistributive policies, reduce inequality of income distribution
and increase equity
What is an equitable distribution of income?

4. Accepting market outcomes but providing a
safety net for those who cannot earn.
 Welfare

available, food stamps, Medicaid
5. Creating Complete Equality
 Communist
countries, equality of income distribution.
Unlikely that this actually occurred. These Economies
failed 1990s
INCOME


Income is a flow – measured as an amount per time period.
All income is taxed in NZ.
Income may be classified as:
Salary
Calculated per year
Wage
Calculated per hour
Fee
For performing a task
Commission
A % of sales
Dividend
A share of profits in a company
Interest
For the use of money
Royalty
For book, song.
Rent
For property
Profit
Firms income
Income from
labour/human effort
Income from
ownership of
asset
Life cycle
page
258
WEALTH




Wealth refers to the ownership of assets.
Includes physical assets such as property &
businesses.
Also includes financial assets such as money &
shares.
Wealth is not taxed in NZ (nor is any capital gain
on wealth).
INCOME & WEALTH


Income can be used to accumulate wealth – savings
can be used to buy property or shares.
Wealth can be used to earn income – savings can
generate interest, shares generate dividends and
property generates rent.
LORENZ CURVES

Shows graphically the relationship between the
cumulative % of households and the cumulative % of
income that they earn
.


“Income” may be defined as market income or disposal
income. ( Disposable income = Market Income +
transfers - taxes.)
“Income” may be measured as individual or household
income (usually the latter).
Decile
%
Cumulative Income Cumulative
Households %
%
%
Households
Income
1
10
10
3.2
3.2
2
10
20
4.1
7.3
3
10
5.0
4
10
30
40
6.4
12.3
18.7
5
10
7.7
26.4
6
10
50
60
9.0
35.4
7
10
70
11.8
47.2
8
10
12.9
9
10
80
90
16.0
60.1
76.1
10
10
100
23.9
100
Household income data page 260
• Households are ranked from those with the lowest
incomes to those with the highest incomes then
grouped into deciles (tenths)
• The lowest decile means the 10% of
households with the lowest incomes.
• The second decile means the second 10% of
households
% INCOME
% Income
100
90
80
70
60
50
40
30
20
10
Decile
0
10 20 30 40 50 60 70 80 90 100
Households
CUMULATIVE % INCOME
Cumulative%
Income
100
90
80
70
60
50
40
30
20
10
Decile
0
10 20 30 40 50 60 70 80 90 100
Households
LORENZ CURVE
Cum
%
income
45* line
represents
equality of
income
Lorenz curve
measures
inequality of
income
distribution
% households
LORENZ CURVE
Cum
%
income
If Lorenz curve
moves outwards
then income
distribution has
become more
unequal
In this case, the Gini
coefficient (area
between Lorenz curve
and equality line) has
become greater
% households
Lorenz Curve
Gini Coefficient

LORENZ CURVE_ Limitations



Lorenz Curve of income distribution does not measure
wealth effects. Some people may be “income poor” yet
“asset rich”
Income measurement does not take into account lifecycle
stages. A student may be poor due to the early of their
career.
Income measurement does not measure non-market
activity which can make a difference to a households
standard of living.
Tools for Re-Distribution







In many countries the government believes the market
distribution of income is inequitable. It therefore uses some
tools to re-distribute income and make the distribution more
equal. Some tools are
Progressive income tax
Transfer payments
Public provision
Minimum wage legislation
Equal opportunity initiatives
Positive discrimination
Progressive Income Taxes


Taxes are compulsory payments to the government. By
taxing the rich more than they poor, income inequalities
can be reduced.
Three types of taxes
 Progressive
– Tax rate increases as income increases. Most
effective tax type for redistribution.
 Proportional - All income taxed at the same rate
 Regressive – Lows on lower incomes paying a higher
proportion of their total income on tax. E.g. GST
Equity and Taxation

Progressive taxation leads to an increase in equity.

Regressive taxation will lead to a fall in equity.
Transfers


Welfare benefits are transfers from the government to
those that cannot provide for themselves or need
assistance.
Benefits become available for people in case of






Sickness
Accident
Unemployment
Old age
Disability
Benefits can be targeted (available to a certain group,
unemployment) or universal ( available to everyone, superannuation)
Welfare Trap



Danger with targeted assistance.
The situation where person’s income increases and
because of means testing, level of entitlement to
benefits decreases.
People can get trapped into narrow income
brackets and loose the incentive to better their
circumstances.
Public Provision


The government provides some goods and services
free of charge. (Hospitals, health care, state
schools)
The basic level of such services are available to
everyone.
Subsidies

The government subsidies a range of goods and
services, such as visits to the doctor for some groups,
job training, tertiary education, and perscription
medicines.
Regulations

Minimum wages
 To
prevent employers from exploiting their workers and
to promote equity.

Equality of Opportunity
 Public
provision of collective goods provides equality,
to ensure all Nzers

Affirmative Action
EQIUTY/EFFICIENCY TRADE OFF
EFFICIENCY
A
B
EQUITY
When a government attempts to
achieve a more equitable income
distribution by re-distributing market
income, it may cause losses in
efficiency in the operation of the market.
This is an opportunity cost which should
be considered.
LOSS OF EFFICIENCY
Disincentives to work or take risks
Progressive income taxes
Transfer payments
Compliance costs increase
Disincentives to work
Public provision
No clear price signals
for resource allocation
Minimum wages
May creates
disequilibrium in the
labour market