The Fallacy Of the Equity Vs Efficiency Tradeoff.

This is an elaboration of a note I prepared in February 1995.

Keywords: History of Ideas, Methodology & Philosophy; Social Policy;

It is much easier to claim there is an equity-efficiency tradeoff, than to demonstrate that there is not, since the terms being used may have a meanings different from conventional usage, so the critic is reduced to chasing ill defined chameleon like ideas.

The following standard economic analysis explains how the term efficiency in a tradeoff must have a different meaning from that which is standard in economics. In order to make this clear, the word efficiency is put in italics whenever it is referring to the context of something which can be traded off against equity.

The analysis is based on a standard tradeoff diagram shown as Figure 1. On the vertical axis is measured “equity” and on the horizontal axis efficiency.

On the diagram we can show all the possible arrangements of the equity and efficiency outputs that are possible for a given set of resources. Rather than mark them all – they are obviously likely to form a dense set, we show where they are located. This consists of the area bound by the axes OE and OA, and the convex curve ABCDE. This is called the production possibility set.

FIGURE: The Efficiency-Equity Tradeoff

The curve ABCDE is called the “production possibility frontier”. In particular B is the point at which the maximum amount of equity that can be obtained for the given amount of efficiency B1. The amount of equity is B2. ( Similarly B is also the maximum amount of efficiency (an amount of B1), which can be obtained for a given amount of equity B2.)

The generally downward sloping frontier (i.e running from the North West to the South East) means that along the production possibility frontier an increase in one output can only be obtained by a decrease in the other. Thus as the production pattern moves from C to D, the amount of equity falls from C2 to D2, while the amount of efficiency increases from C1 to D1. This is what economists mean by the “tradeoff” between the two outputs.

But consider the point P (C2,D1) within the production possibility frontier. That point is an inefficient application of the resources, since an alternative arrangement can obtain more equity (up to C2) or more efficiency (up to D2), or some combination of the two. Thus there is an increase in efficiency (roman rather than italics) by moving from an interior point to the frontier. Here we are using “efficiency” in the standard economics meaning – an improvement in efficiency gives more output for the same amount of resources.

It should be evident that efficiency, as represented by the horizontal axis, has quite a different meaning from efficiency, as represented by the shift from an interior point onto the frontier. If there is any doubt about this consider the shift from P to B. Economic efficiency increases (because there is a movement from an interior to frontier point – which is however, unlikely, to be a Pareto efficient move) but efficiency decreases from C1 to B1. This is only paradoxical if we think the two terms have the same meaning.

What is the meaning of efficiency is something that those who claim there is a tradeoff have to explain, but rarely do. However in a longer paper I show that the term efficiency is frequently used to mean the situation with a particular (pro-rich) set of equity assumptions.(1) If that is intended to apply in a tradeoff analysis, then the notion of a tradeoff becomes even more nonsensical. An equity assumption is built into the efficiency notion, while the analysis purports to treat equity as conceptually independent from efficiency.

(1) B.H. Easton, “Notes Towards the Distributional Consequences of Policy Changes”, Social Policy and Inequality in Australia and New Zealand, Social Welfare Research Centre Reports and Proceedings, No 78, September 1989. p.171-194. This will be put up on the website in due course.