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

Wage

Fee

Commission

Dividend

Interest

Royalty

Rent

Profit

Calculated per year

Calculated per hour

For performing a task

A % of sales

A share of profits in a company

For the use of money

For book, song.

For property

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 % Households

Cumulative%Households

Income%

Cumulative% Income

1 10 3.2

2 10 4.1

3 10 5.0

4 10 6.4

5 10 7.7

6 10 9.0

7 10 11.8

8 10 12.9

9 10 16.0

10 10 23.9

3.2

7.3

12.318.7

26.4

35.4

47.2

60.176.1

100

10

20

3040

5060

70

8090

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

Decile

Households

100

90

80

70

60

50

40

30

20

10

010 20 30 40 50 60 70 80 90 100

% Income

CUMULATIVE % INCOME

Decile

Households

100

90

80

70

60

50

40

30

20

10

010 20 30 40 50 60 70 80 90 100

Cumulative% Income

LORENZ CURVE

% households

Cum

%

income

45* line represents equality of

income

Lorenz curve measures

inequality of income

distribution

LORENZ CURVE

% households

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

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

EQUITY

EFFICIENCY

A

B

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

Progressive income taxesDisincentives to work or take risks

Compliance costs increase

Transfer payments Disincentives to work

Public provision No clear price signals for resource allocation

Minimum wages May creates disequilibrium in the labour market