1.7 — Efficiency & Justice

ECON 410 • Public Economics • Spring 2022

Ryan Safner
Assistant Professor of Economics
safner@hood.edu
ryansafner/publicS22
publicS22.classes.ryansafner.com

Efficiency

Common tradeoff between efficiency and equity
Efficiency: efforts to grow the economic pie
Equity: efforts to divide the pie fairly
What is the role of the government in either?

Markets and Efficiency

Economists traditionally care most about efficiency
Achieving a specified goal with as few resources as possible
Examples:
- driving a car
- carrying groceries
- producing jeans

Problem: What “Goal” for Society?

We will ruminate more in the next few units
Society, government, etc. has no single, universally-agreed upon goal
- It’s not maximizing utility, profit, etc!
“Society” is not a choosing agent!

Markets and Efficiency

Preferences are subjective and left as given in economics
- We leave it to individuals to be the best judge of whether they are better off
- Egalitarian to a degree: nobody's preferences are dismissed or discounted
Higher incomes + freedom of choice = greater degree of preference satisfaction
Harder to directly evaluate outcomes
- Better to look at basic processes & mechanisms (e.g. exchange)

Voluntary Exchange is Good

In a voluntary exchange, both parties expect to be made better off
Trade corrects mistakes in resource allocation
The best justification for reallocation of resources (even via coercion) is consent

Markets and Pareto Efficiency

Voluntary exchange is a Pareto improvement: change in allocation that makes at least one person better off and making nobody worse off
An allocation of resources is Pareto efficient when there are no possible Pareto improvements

Markets and Pareto Efficiency

Pareto efficiency is conceptual gold standard: allow all welfare-improving exchanges so long as nobody gets harmed
In practice: Pareto efficiency is a first best solution
- only takes one holdout to disapprove to violate Pareto

Markets and Kaldor-Hicks Efficiency

Kaldor-Hicks Improvement: an action improves efficiency its generates more social gains than losses
- those made better off could in principle compensate those made worse off
Kaldor-Hicks efficiency: no potential Kaldor-Hicks improvements exist
Keeps intuitive appeal of Pareto but more practical
- Every Pareto improvement is a KH-improvement (but not the other way around!)
Consider policies where winners' maximum WTP $>$ losers' minimum WTA
Policies should maximize social value of resources

Market Efficiency in Competitive Equilibrium I

Allocative efficiency: resources are allocated to highest-valued uses
- Goods produced up to the point where $M B = M C$ $(p = M C)$
- Maximize economic surplus $=$ Consumer surplus $+$ Producer surplus
Pareto efficient: no possible Pareto improvements exist

Problem 1: Resources have multiple uses and are rivalrous
Problem 2: Different people have different subjective valuations for uses of resources
It is inefficient (immoral?) to use a resource in a way that prevents someone else who values it more from using it!

Markets are institutions that facilitate voluntary impersonal exchange and reduce transaction costs
Prices measure opportunity cost of a particular use of a resource

Property rights provide a pattern of ownership
Prices give us information about how to use scarce resources
Profits incentivize production and Losses discipline waste

Welfare Economics

1st Fundamental Welfare Theorem: markets in competitive equilibrium maximize allocative efficiency of resources and are Pareto efficient
Markets are great when they:

Are Competitive: many buyers and many sellers
Reach equilibrium: absence of transactions costs or policies preventing prices from adjusting to meet supply and demand
No externalities are present: costs and benefits are fully internalized by the parties to transactions

Justice

What is justice?

“Fiat justitia ruat caelum”

Absence of injustices?
Utilitarian/consequentialist vs. deontological/natural rights views of justice

Distributive Justice

Distributive justice about the distribution of economic outcomes
- property rights, income, wealth, political power
- Overlap with social justice?
Is the current distribution just?
Is there a case for reallocating resources (by coercion)?

"Pareto" power-law distribution

(In)equality within Countries: Gini Coefficient I

Source: Our World in Data: Income Inequality

(In)equality within Countries: Gini Coefficient II

Source: Wikipedia

(In)equality within Countries: Lower in Wealthier Countries

Source: Our World in Data: Income Inequality

(In)equality within Countries: But Changing Over Time

Source: Our World in Data: Income Inequality

(In)equality Across Countries Over Time

Source: Our World in Data: Income Inequality

Aside: Equality vs. Equity

Distributive Justice: Rawls vs. Nozick

John Rawls

Robert Nozick

Rawls: Overview

John Rawls

1921--2002

1971, Justice as Fairness
One of the most influential political philosophers in the 20^th century
A liberal social contract theory of the State
Aims to reconcile liberty and equality; uncover principles of justice necessary for a good society
- Allowing for pluralistic definition of "the good"

Rawls: The Original Position

John Rawls

1921--2002

"Original position" where all participants of society determine the principles of justice for their society behind a veil of ignorance, where

"...no one knows his place in society, his class position or social status, nor does anyone know his fortune in the distribution of natural assets and abilities, his intelligence, strength, [or even] their conceptions of the good or their special psychological propensities."

Rawls: Reflective Equilibrium

John Rawls

1921--2002

Rational individuals form a social contract to provide rules
If individuals do not know their relative positions in society, what would the reflective equlibrium be for the rules they establish to govern themselves?
What rules would we expect all rational individuals to agree upon and view as fair?
- Ahistorical, but we can compare real world policies and changes to this ideal outcome

Rawls' Principles of Justice

John Rawls

1921--2002

Greatest equal liberty principle: Each person is to have an equal right to the most extensive total system of equal basic liberties compatible with a similar system of liberty for all
Difference principle: Social and economic inequalities are to be arranged so that they are both: (a) the greatest benefit to the least advantaged...[and] (b) attached to offices open to all under conditions of fair equality of opportunity

Rawls' Principles of Justice

John Rawls

1921--2002

Liberty is first priority (first principle)
Inequalities are permitted to encourage division of labor and specialization, provided they benefit the worst off

Rawls' Justification

John Rawls

1921--2002

Justification of difference principle:
Why not a pure meritocracy with an "equal start"?
The start is not truly equal, result of "morally arbitrary" factors
- A genetic lottery of talent, born into family, etc.
- Hard to claim that people deserve better outcomes because of these factors
So focus on making the worst off best

Distributive Justice: Example


D1D1
D2D2
D3D3


Person A
10
3
6

Person B
6
3
5

Person C
2
3
4

Total
18
9
15

Average
6
3
5



  

Distributive Justice: Example


D1D1
D2D2
D3D3


Person A
10
3
6

Person B
6
3
5

Person C
2
3
4

Total
18
9
15

Average
6
3
5


Utilitarian: maximize total utility (D1)(D1)


  

Distributive Justice: Example

	$D_{1}$	$D_{2}$	$D_{3}$
Person A	10	3	6
Person B	6	3	5
Person C	2	3	4
Total	18	9	15
Average	6	3	5

Utilitarian: maximize total utility $(D_{1})$
Egalitarian: equalize distribution $(D_{2})$

Distributive Justice: Example

	$D_{1}$	$D_{2}$	$D_{3}$
Person A	10	3	6
Person B	6	3	5
Person C	2	3	4
Total	18	9	15
Average	6	3	5

Utilitarian: maximize total utility $(D_{1})$
Egalitarian: equalize distribution $(D_{2})$
Rawlsian: distribution that maximizes benefit to the worst off $(D_{3})$

Distributive Justice: Example

	$D_{1}$	$D_{2}$	$D_{3}$
Person A	10	3	6
Person B	6	3	5
Person C	2	3	4
Total	18	9	15
Average	6	3	5

Utilitarian: maximize total utility $(D_{1})$
Egalitarian: equalize distribution $(D_{2})$
Rawlsian: distribution that maximizes benefit to the worst off $(D_{3})$
- Focus on absolute position of worst off, rather than their relative position

Nozick: Overview

Robert Nozick

1938-2002

1974, Anarchy, State, and Utopia
Most influential response to Rawls
Influenced by John Locke, Immanuel Kant, and F. A. Hayek
The most mainstream libertarian/classical liberal philosopher in 20^th Century
Gives a libertarian account of rights, the origins of the State, and advocates for a minimalist "nightwatchman" State

Nozick: Distributive Justice?

Robert Nozick

1938-2002

"Distributive justice" is a squishy and non-neutral concept
A category mistake: there is no "stock" of things to be distributed and no "one" doing the distributing

Nozick: On Rawls

Robert Nozick

1938-2002

Rawls' justice is a patterned or an end-state theory of justice

"Liberty upsets patterns"

Enforcing the pattern requires continually violating individual rights
Redistribution would have to violate self-ownership and prohibit "capitalist acts between consenting adults"

Nozick's Theory of Justice

Robert Nozick

1938-2002

Nozick's is a non-patterned entitlement theory of justice
Based heavily on John Locke's theory of property

Locke's Theory of Property

John Locke

1632-1704

"Though the earth, and all inferior creatures, be common to all men, yet every man has a property in his own person: this no body has any right to but himself. The labour of his body, and the work of his hands, we may say, are properly his. Whatsoever then he removes out of the state that nature hath provided, and left it in, he hath mixed his labour with, and joined to it something that is his own, and thereby makes it his property...that excludes the common right of other men: for this labour being the unquestionable property of the labourer, no man but he can have a right to what that is once joined to, at least where there is enough, and as good, left in common for others," (Ch. V).

Locke, John, 1689, Second Treatise on Government

Nozick's Theory of Justice

Robert Nozick

1938-2002

Nozick: individuals are entitled to their holdings if:
1. Their property was acquired justly
2. They transfer holdings via consent
Holdings are unjust if they violate 1 or 2
- Rectification to redress these violations is just

Nozick vs Rawls

	$D_{1}$
Person A	100
Person B	100
$⋮$	$⋮$

Nozick's famous example:

Imagine original distribution $D_{1}$ that satisfies your favorite patterned principle (e.g. Rawlsian)

Nozick vs Rawls

	$D_{1}$
Person A	100
Person B	100
$⋮$	$⋮$
LeBron James	100

Nozick's famous example:

Imagine original distribution $D_{1}$ that satisfies your favorite patterned principle (e.g. Rawlsian)
Everyone freely decides to pay $1 to watch LeBron James play basketball

Nozick vs Rawls

	$D_{1}$	$D_{2}$
Person A	100	99
Person B	100	99
$⋮$	$⋮$	$⋮$
LeBron James	100	1,000,000

Nozick's famous example:

James now has a million, a much larger sum than any of the other people in society
$D_{2}$ is no longer ordered by our patterned principle
Nozick: how can $D_{2}$ be considered an "unjust distribution"?

Nozick's Theory of Justice

Robert Nozick

1938-2002

How can $D_{2}$ be unjust if it was attained by a just process?
On what grounds can we justify redistribution to maintain a pattern?
No patterned principle of justice is compatible with individual rights

1.7 — Efficiency & Justice

ECON 410 • Public Economics • Spring 2022

Ryan Safner
Assistant Professor of Economics
safner@hood.edu
ryansafner/publicS22
publicS22.classes.ryansafner.com

Efficiency

Common tradeoff between efficiency and equity
Efficiency: efforts to grow the economic pie
Equity: efforts to divide the pie fairly
What is the role of the government in either?

Markets and Efficiency

Economists traditionally care most about efficiency
Achieving a specified goal with as few resources as possible
Examples:
- driving a car
- carrying groceries
- producing jeans

Problem: What “Goal” for Society?

We will ruminate more in the next few units
Society, government, etc. has no single, universally-agreed upon goal
- It’s not maximizing utility, profit, etc!
“Society” is not a choosing agent!

Markets and Efficiency

Preferences are subjective and left as given in economics
- We leave it to individuals to be the best judge of whether they are better off
- Egalitarian to a degree: nobody's preferences are dismissed or discounted
Higher incomes + freedom of choice = greater degree of preference satisfaction
Harder to directly evaluate outcomes
- Better to look at basic processes & mechanisms (e.g. exchange)

Voluntary Exchange is Good

In a voluntary exchange, both parties expect to be made better off
Trade corrects mistakes in resource allocation
The best justification for reallocation of resources (even via coercion) is consent

Markets and Pareto Efficiency

Voluntary exchange is a Pareto improvement: change in allocation that makes at least one person better off and making nobody worse off
An allocation of resources is Pareto efficient when there are no possible Pareto improvements

Markets and Pareto Efficiency

Pareto efficiency is conceptual gold standard: allow all welfare-improving exchanges so long as nobody gets harmed
In practice: Pareto efficiency is a first best solution
- only takes one holdout to disapprove to violate Pareto

Markets and Kaldor-Hicks Efficiency

Kaldor-Hicks Improvement: an action improves efficiency its generates more social gains than losses
- those made better off could in principle compensate those made worse off
Kaldor-Hicks efficiency: no potential Kaldor-Hicks improvements exist
Keeps intuitive appeal of Pareto but more practical
- Every Pareto improvement is a KH-improvement (but not the other way around!)
Consider policies where winners' maximum WTP $>$ losers' minimum WTA
Policies should maximize social value of resources

Market Efficiency in Competitive Equilibrium I

Allocative efficiency: resources are allocated to highest-valued uses
- Goods produced up to the point where $M B = M C$ $(p = M C)$
- Maximize economic surplus $=$ Consumer surplus $+$ Producer surplus
Pareto efficient: no possible Pareto improvements exist

Problem 1: Resources have multiple uses and are rivalrous
Problem 2: Different people have different subjective valuations for uses of resources
It is inefficient (immoral?) to use a resource in a way that prevents someone else who values it more from using it!

Markets are institutions that facilitate voluntary impersonal exchange and reduce transaction costs
Prices measure opportunity cost of a particular use of a resource

Property rights provide a pattern of ownership
Prices give us information about how to use scarce resources
Profits incentivize production and Losses discipline waste

Welfare Economics

1st Fundamental Welfare Theorem: markets in competitive equilibrium maximize allocative efficiency of resources and are Pareto efficient
Markets are great when they:

Are Competitive: many buyers and many sellers
Reach equilibrium: absence of transactions costs or policies preventing prices from adjusting to meet supply and demand
No externalities are present: costs and benefits are fully internalized by the parties to transactions

Justice

What is justice?

“Fiat justitia ruat caelum”

Absence of injustices?
Utilitarian/consequentialist vs. deontological/natural rights views of justice

Distributive Justice

Distributive justice about the distribution of economic outcomes
- property rights, income, wealth, political power
- Overlap with social justice?
Is the current distribution just?
Is there a case for reallocating resources (by coercion)?

"Pareto" power-law distribution

(In)equality within Countries: Gini Coefficient I

Source: Our World in Data: Income Inequality

(In)equality within Countries: Gini Coefficient II

Source: Wikipedia

(In)equality within Countries: Lower in Wealthier Countries

Source: Our World in Data: Income Inequality

(In)equality within Countries: But Changing Over Time

Source: Our World in Data: Income Inequality

(In)equality Across Countries Over Time

Source: Our World in Data: Income Inequality

Aside: Equality vs. Equity

Distributive Justice: Rawls vs. Nozick

John Rawls

Robert Nozick

Rawls: Overview

John Rawls

1921--2002

1971, Justice as Fairness
One of the most influential political philosophers in the 20^th century
A liberal social contract theory of the State
Aims to reconcile liberty and equality; uncover principles of justice necessary for a good society
- Allowing for pluralistic definition of "the good"

Rawls: The Original Position

John Rawls

1921--2002

"Original position" where all participants of society determine the principles of justice for their society behind a veil of ignorance, where

"...no one knows his place in society, his class position or social status, nor does anyone know his fortune in the distribution of natural assets and abilities, his intelligence, strength, [or even] their conceptions of the good or their special psychological propensities."

Rawls: Reflective Equilibrium

John Rawls

1921--2002

Rational individuals form a social contract to provide rules
If individuals do not know their relative positions in society, what would the reflective equlibrium be for the rules they establish to govern themselves?
What rules would we expect all rational individuals to agree upon and view as fair?
- Ahistorical, but we can compare real world policies and changes to this ideal outcome

Rawls' Principles of Justice

John Rawls

1921--2002

Greatest equal liberty principle: Each person is to have an equal right to the most extensive total system of equal basic liberties compatible with a similar system of liberty for all
Difference principle: Social and economic inequalities are to be arranged so that they are both: (a) the greatest benefit to the least advantaged...[and] (b) attached to offices open to all under conditions of fair equality of opportunity

Rawls' Principles of Justice

John Rawls

1921--2002

Liberty is first priority (first principle)
Inequalities are permitted to encourage division of labor and specialization, provided they benefit the worst off

Rawls' Justification

John Rawls

1921--2002

Justification of difference principle:
Why not a pure meritocracy with an "equal start"?
The start is not truly equal, result of "morally arbitrary" factors
- A genetic lottery of talent, born into family, etc.
- Hard to claim that people deserve better outcomes because of these factors
So focus on making the worst off best

Distributive Justice: Example


D1D1
D2D2
D3D3


Person A
10
3
6

Person B
6
3
5

Person C
2
3
4

Total
18
9
15

Average
6
3
5



  

Distributive Justice: Example


D1D1
D2D2
D3D3


Person A
10
3
6

Person B
6
3
5

Person C
2
3
4

Total
18
9
15

Average
6
3
5


Utilitarian: maximize total utility (D1)(D1)


  

Distributive Justice: Example

	$D_{1}$	$D_{2}$	$D_{3}$
Person A	10	3	6
Person B	6	3	5
Person C	2	3	4
Total	18	9	15
Average	6	3	5

Utilitarian: maximize total utility $(D_{1})$
Egalitarian: equalize distribution $(D_{2})$

Distributive Justice: Example

	$D_{1}$	$D_{2}$	$D_{3}$
Person A	10	3	6
Person B	6	3	5
Person C	2	3	4
Total	18	9	15
Average	6	3	5

Utilitarian: maximize total utility $(D_{1})$
Egalitarian: equalize distribution $(D_{2})$
Rawlsian: distribution that maximizes benefit to the worst off $(D_{3})$

Distributive Justice: Example

	$D_{1}$	$D_{2}$	$D_{3}$
Person A	10	3	6
Person B	6	3	5
Person C	2	3	4
Total	18	9	15
Average	6	3	5

Utilitarian: maximize total utility $(D_{1})$
Egalitarian: equalize distribution $(D_{2})$
Rawlsian: distribution that maximizes benefit to the worst off $(D_{3})$
- Focus on absolute position of worst off, rather than their relative position

Nozick: Overview

Robert Nozick

1938-2002

1974, Anarchy, State, and Utopia
Most influential response to Rawls
Influenced by John Locke, Immanuel Kant, and F. A. Hayek
The most mainstream libertarian/classical liberal philosopher in 20^th Century
Gives a libertarian account of rights, the origins of the State, and advocates for a minimalist "nightwatchman" State

Nozick: Distributive Justice?

Robert Nozick

1938-2002

"Distributive justice" is a squishy and non-neutral concept
A category mistake: there is no "stock" of things to be distributed and no "one" doing the distributing

Nozick: On Rawls

Robert Nozick

1938-2002

Rawls' justice is a patterned or an end-state theory of justice

"Liberty upsets patterns"

Enforcing the pattern requires continually violating individual rights
Redistribution would have to violate self-ownership and prohibit "capitalist acts between consenting adults"

Nozick's Theory of Justice

Robert Nozick

1938-2002

Nozick's is a non-patterned entitlement theory of justice
Based heavily on John Locke's theory of property

Locke's Theory of Property

John Locke

1632-1704

"Though the earth, and all inferior creatures, be common to all men, yet every man has a property in his own person: this no body has any right to but himself. The labour of his body, and the work of his hands, we may say, are properly his. Whatsoever then he removes out of the state that nature hath provided, and left it in, he hath mixed his labour with, and joined to it something that is his own, and thereby makes it his property...that excludes the common right of other men: for this labour being the unquestionable property of the labourer, no man but he can have a right to what that is once joined to, at least where there is enough, and as good, left in common for others," (Ch. V).

Locke, John, 1689, Second Treatise on Government

Nozick's Theory of Justice

Robert Nozick

1938-2002

Nozick: individuals are entitled to their holdings if:
1. Their property was acquired justly
2. They transfer holdings via consent
Holdings are unjust if they violate 1 or 2
- Rectification to redress these violations is just

Nozick vs Rawls

	$D_{1}$
Person A	100
Person B	100
$⋮$	$⋮$

Nozick's famous example:

Imagine original distribution $D_{1}$ that satisfies your favorite patterned principle (e.g. Rawlsian)

Nozick vs Rawls

	$D_{1}$
Person A	100
Person B	100
$⋮$	$⋮$
LeBron James	100

Nozick's famous example:

Imagine original distribution $D_{1}$ that satisfies your favorite patterned principle (e.g. Rawlsian)
Everyone freely decides to pay $1 to watch LeBron James play basketball

Nozick vs Rawls

	$D_{1}$	$D_{2}$
Person A	100	99
Person B	100	99
$⋮$	$⋮$	$⋮$
LeBron James	100	1,000,000

Nozick's famous example:

James now has a million, a much larger sum than any of the other people in society
$D_{2}$ is no longer ordered by our patterned principle
Nozick: how can $D_{2}$ be considered an "unjust distribution"?

Nozick's Theory of Justice

Robert Nozick

1938-2002

How can $D_{2}$ be unjust if it was attained by a just process?
On what grounds can we justify redistribution to maintain a pattern?
No patterned principle of justice is compatible with individual rights

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1.7 — Efficiency & Justice

ECON 410 • Public Economics • Spring 2022

Ryan Safner Assistant Professor of Economics safner@hood.edu ryansafner/publicS22 publicS22.classes.ryansafner.com

Efficiency

Efficiency

Markets and Efficiency

Problem: What “Goal” for Society?

Markets and Efficiency

Voluntary Exchange is Good

Markets and Pareto Efficiency

Markets and Pareto Efficiency

Markets and Kaldor-Hicks Efficiency

Market Efficiency in Competitive Equilibrium I

Social Problems that Markets Solve Well

Social Problems that Markets Solve Well I

Social Problems that Markets Solve Well II

Welfare Economics

Justice

Justice

Distributive Justice

(In)equality within Countries: Gini Coefficient I

(In)equality within Countries: Gini Coefficient II

(In)equality within Countries: Lower in Wealthier Countries

(In)equality within Countries: But Changing Over Time

(In)equality Across Countries Over Time

Aside: Equality vs. Equity

Distributive Justice: Rawls vs. Nozick

Rawls: Overview

Rawls: The Original Position

Rawls: Reflective Equilibrium

Rawls' Principles of Justice

Rawls' Principles of Justice

Rawls' Justification

Distributive Justice: Example

Distributive Justice: Example

Distributive Justice: Example

Distributive Justice: Example

Distributive Justice: Example

Nozick: Overview

Nozick: Distributive Justice?

Nozick: On Rawls

Nozick's Theory of Justice

Locke's Theory of Property

Nozick's Theory of Justice

Nozick vs Rawls

Nozick vs Rawls

Nozick vs Rawls

Nozick's Theory of Justice

Efficiency

Help

1.7 — Efficiency & Justice

1.7 — Efficiency & Justice

ECON 410 • Public Economics • Spring 2022

Ryan Safner Assistant Professor of Economics safner@hood.edu ryansafner/publicS22 publicS22.classes.ryansafner.com

Efficiency

Efficiency

Markets and Efficiency

Problem: What “Goal” for Society?

Markets and Efficiency

Voluntary Exchange is Good

Markets and Pareto Efficiency

Markets and Pareto Efficiency

Markets and Kaldor-Hicks Efficiency

Market Efficiency in Competitive Equilibrium I

Social Problems that Markets Solve Well

Social Problems that Markets Solve Well I

Social Problems that Markets Solve Well II

Welfare Economics

Justice

Justice

Distributive Justice

(In)equality within Countries: Gini Coefficient I

(In)equality within Countries: Gini Coefficient II

(In)equality within Countries: Lower in Wealthier Countries

(In)equality within Countries: But Changing Over Time

(In)equality Across Countries Over Time

Aside: Equality vs. Equity

Distributive Justice: Rawls vs. Nozick

Rawls: Overview

Rawls: The Original Position

Ryan Safner
Assistant Professor of Economics
safner@hood.edu
ryansafner/publicS22
publicS22.classes.ryansafner.com

Ryan Safner
Assistant Professor of Economics
safner@hood.edu
ryansafner/publicS22
publicS22.classes.ryansafner.com