Modern economics is a wide subject that deals with many different aspects. Efficiency, equity, and effectiveness are the three E's that are clearly among the biggest issues with economics. To understand these concepts is to understand what it means to make good economic decisions. Economic growth is not only about having a booming economy at one given time but more about sustainability. We live in a world where human needs are unlimited, yet the natural resources they rely on are limited and keep reducing. Problems of population, population, and many other similar issues keep making things harder.
Yet, there is a need to make decisions that affect positive growth in the economy and create equity, efficiency, and effectiveness for sustainable development. The government is mandated, in many cases, with the task of allocating and distributing these limited resources. But these aspects remain one of the biggest issues in many economies. It is hard enough to have effective working systems, and it's made worse by lack of equity.
Public finance is a wide subject that deals with these issues. Any economy that does not have proper public finance systems is doomed to fail. The subject deals with how the government collect revenues and how it uses the same to meet its national development goals. Fiscal policy is the exact feature that explains government expenditure and taxation that the government may use this policy to change the cause of an economic phase.
For instance, during a recession, expansionary fiscal policy is used to boost the economy. Here, the government will increase spending while reducing taxes to make sure more people are consuming different goods, which boosts the general economy. And when the economy is booming, the government may decide to use contractionary fiscal policy, reducing spending and increasing taxes. This can be affected especially during a bubble, to protect the economy from negative growth.
In all, efficiency and equity are the main features that determine the effectiveness of the results of these efforts. This means we can only tell if a method to restore the economy was effective through its general effect on society. Therefore, it's crucial to understand what these terms mean and how they can be used in economic development. A student taking economics and finance as their major will have to understand what efficiency and equity mean to society.
In the guide, we will be talking about efficiency and equity as agents of sustainable development. Note that this is one of the goals of every internal body today. The deteriorating natural environment is a concern for everyone, and perhaps sustainable economic development is the answer. It seeks to improve human life while taking care of the environment at the same time.
Another key point to note here is that there cannot be economic development without sacrificing the environment. When new industries are built, they create more jobs, leading to more jobs and eventually boosting the economy. But this also means there will be more emissions that are harmful to the environment.
Most importantly is the problem of scarcity. How can scarce resources be used for effective production? And how can these resources be distributed equally among society members to have everyone smiling at the same level? These and many others are questions that economists and policymakers face every day. It is crucial to have the resources equally shared while ensuring there is optimal production within the economy. The faceoff between efficiency and equity is a big problem in the economy.
Let us step back a bit and think about the supply theory in economics. Doing this will allow us to understand how companies make decisions that affect their growth and the society they are built-in. The relationship between consumers and suppliers is what defines markets and economic growth. Firms are the suppliers, while households are the consumers in standard commodity markets. It's only in the labor market that firms provide demand while households are the supply.
As stated above, the resources, and in this case, the resources for producing the end products, are limited. A company has to ensure they are reaping maximum products from what they are producing while making sure the market can afford the same. It does not make sense when a company running a production line fails to make any profits. This is the main aim of every firm, and they must consider this in every step of the production.
Pricing is the key to profit maximization. The company will have to include the cost of the product, from the raw material to marketing to transportation, until it reaches the end-user. With these in mind, the firm is able to make proper decisions that will give them maximum profit. A good way to reap all the profit would be to reduce the production cost as much as possible. This would include cutting wages for employees working in production lines, avoiding marketing, and perhaps working in markets that don't demand too much in terms of transportation when supplying the final goods.
And this brings us to the issue of efficiency. How can a company achieve efficiency without sacrificing the other factors?
Efficiency can be defined as to do with optimal production and allocation of resources given the existing factors of production. For instance, a company needs to produce at the lowest cost if they are seeking to make the most profit. This can mean many things for a market. Pricing is a major issue that determines both production and consumption. In a perfect-competition-market, firms are price takers. This means they do not have to influence the set prices because everyone knows the value of the goods. Imperfect competition markets are, however, different. Consumers are the price takers, and firms can set the prices based on the features of their goods. But they have to be careful doing it because another company selling the same product at a lower price may take them out of business.
Efficiency can, therefore, be viewed as what a business does to achieve optimal production and the allocation of resources. The decisions made in this effect must put into consideration the existing factors of production. If there is anything that can be done to create a perfect production, the company needs to put it into consideration. Efficiency goes beyond the needs of individual companies and into the societies they operate in. Hence, the issues of pollution resulting from emissions from the firm's operations have to be considered.
Government interventions are another aspect of efficiency that must be considered. This comes in terms of taxes and levies imposed on pollution charges. The government can impose high taxes for these factors to discourage production or use other legal means that ensure the manufacturer is applying safety for the community before doing anything else. This way, they can ensure that efficiency flows all the way they don't to the end-user.
There are several types of efficiency, each concerned with achieving specific results. Here are the main types.
As the name suggests, this a type of efficiency that occurs in production. Here, the maximum number of goods and services are produced with a specified amount of input. It will take place on the production possibility frontier, which the lowest point of the firm's average cost curve.
When products are distributed according to consumers' needs, we say the firm has achieved allocative efficiency. A market or economy can achieve productive efficiency but fail to satisfy the consumer. This will mean they have failed in effective allocative efficiency. This type occurs when the prices of the goods are equal to the MC of production.
X efficiency is when the firm has incentives to cut the costs. X-inefficiency can mean the opposite, that the firm lacks the incentive to cut costs. For example, a monopoly market may make abnormal products but lack enough incentives to get rid of surplus labor. If the company's average costs are higher than that potential, we call it the x-inefficiency factor.
Another popular type of efficiency is this efficiency of scale, which occurs when the company produces goods on the lowest scale point of the long-run average cost. Hence, the firm ends up benefitting from the economies of scale.
This is efficiency over time. For instance, a particular firm can be very effective at the moment, but after some time, it loses its relative advantage and, by comparison, would then have become inefficient. Dynamic efficiency is sustained by innovations and finding new ways to satisfy consumers.
Externalities are the impacts of other people's actions, which may or may not be rewarded. If this externality is considered during production, then we have social efficiency. And it happens at an output where the social cost of production is equal to the social benefit.
This efficiency requires a more technical combination of factor inputs to come up with the final good. It has something to do with productive efficiency but in detail.
This is a situation where the distribution of resources is done most effectively. It can be explained as a point where one party cannot be made better off without making another player worse off.
As you may have already guessed, this efficiency is involved with the effective distribution. It happens when goods and services are distributed according to who needs them the most. It, therefore, needs to work on equitable distribution.
We have already mentioned at the beginning that we are living in a world where resources are limited. But this does not mean that we cannot use them effectively. It is all about balancing out the status of everyone within the economy.
Sometimes the government imposes higher taxes on the rich than it does on the poor. The extra money that comes from this step is used in taking care of the less fortunate in society. This is a good example of the distribution of wealth and income.
Equity is an aspect of economics that deals with how resources are distributed through society. The government is mandated to make sure everyone in society gets an equal share of the national resources. This is done through a well-established political system that ensures every citizen is well-represented on different frontiers.
There are two main types of equity, namely, vertical equity horizontal equity.
This type of equity deals with the relative income and welfare of the whole population. For instance, a society is said to have relative poverty when people get less than 50% of average income. This is where the real issue of equitable resources are distributed, and it's where high-income earners are taxed higher.
Horizontal equity is the opposite of vertical equity. Here everyone is treated as being in the same situation. For instance, it can be stated that everyone earning $$10 000 should pay the same tax rates. Hence, those who earn higher are not taxed differently. But it is only effective where everyone in society earns the same.
Equity and efficiency are terms that largely describe the real economy. They affect each other, and hence should be considered at the same time when looking at sustainable economic development. Efficiency may lead to less equity.
Consider the tax poll and cigarette taxes, for instance. In poll tax, each person was expected to pay the same amount, no matter what they earned. Many considered this effective because it does not affect economic behavior. It does not have any incentive to work, though, since the tax pay remains the same even if you work more. However, it was considered unfair because the rich were paying the same tax as the poor. A tax on cigarettes can increase social efficiency. Since cigarettes have negative externalities, it causes a higher social cost than personal cost. People pay the full social cost of smoking, and it also increases social efficiency. However, the cigarette act is very regressive as it takes a bigger percentage of income from low-earners.
Efficiency and equity will always be a problem in economic and sustainable development. However, with a better understanding, we can find ways of dealing with it to create a better environment for positive growth in society.
Jun 02, 2021