14.01SC | Fall 2011 | Undergraduate

Principles of Microeconomics

Unit 7: Equity and Efficiency

« Previous | Next »

The analysis of competitive markets is based on the stated goal of efficiency, or the maximization of social welfare. This ignores potential concerns about equity, the distribution of benefits among the participants in a market economy. In this unit, you will begin to learn about policies that seek to address the balance between efficiency and equity, and what their pros and cons are. These policies include tax and transfer systems, social insurance, and healthcare.

  Equity and Efficiency

  Image courtesy of Vince_Lamb on Flickr.

  Government Redistribution Policy

  Image courtesy of Ed Marshall on Flickr.

  U.S. Social Insurance Programs

  Image courtesy of wisaflcio on Flickr.

  Healthcare Economics

  Image courtesy of University of Nottingham on Flickr.

« Previous | Next »

« Previous | Next »

Session Overview

Up to this point in the course, we have focused only on the outcomes generated by the market and their efficiency properties. Competitive equilibria in a market are typically efficient, but they may not be equitable: Some people may benefit greatly from the market’s operation, while others do not. As a society, we may decide we want to alter these outcomes in a way that seems more equitable, but such changes typically come at the cost of efficiency. In this lecture, we will begin to learn about the efficiency-equity trade-off.

How do we feel about differences in income? This lecture explores this question and the efficiency- equity trade-off. Image courtesy of Vince_Lamb on Flickr.

Keywords: Income distribution; social welfare function; isowelfare curves; Utilitarianism; Raulsian criteria; Nozickian; commodity egalitarianism

Session Activities

Readings

Before watching the Lecture Video, read the course textbook for an introduction to the material covered in this session:

  • [R&T] Chapter 19, “Inequality, Poverty, and Discrimination.” Sections 19.1-2.
  • [Perloff] Chapter 10, “General Equilibrium and Economic Welfare.” (optional)

Lecture Videos

Resources

Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

Assume that society has a utilitarian social welfare function. Under what condition does maximizing the social welfare function call for an equal distribution of income?

 

A utilitarian social welfare function calls for an equal distribution of income when individual utility functions are identical. In this case, social welfare is maximized by allocating an equal amount of income to each individual. If preferences are identical, it does not matter what the shape of those preferences are (i.e., if the marginal utility of income varies with income). However, if preferences are not identical, then maximizing a utilitarian social welfare function may entail a very different distribution of income.

Question 2

An income guarantee program uses a government transfer program to guarantee all individuals a certain amount of income. What is one of the potential negative, efficiency-reducing effects of such a program?

 

If an income guarantee program is implemented, then individuals who might otherwise have worked and earned less than the amount guaranteed by the program will now stop working and rely solely on government transfers for income. This results in a decrease in labor supply, which is efficiency-reducing. There is no impact on labor demand. It is true that the income of the poor increases, but that is not a negative side effect of the policy: it is the goal of the policy.

Further Study

These optional resources are provided for students that wish to explore this topic more fully.

Textbook Study Materials

See the course website for Econ 302, Intermediate Microeconomics taught at Penn State in 2011.

« Previous | Next »

« Previous | Next »

Session Overview

A key element of government policy that determines how much we can redistribute among households is the tax rate. The tax rate is used to raise revenues, which can then be used in government programs. What type of taxes we should use and how high tax rates should be are major questions that economics attempts to answer. This lecture provides an introduction to the economics of taxation.

The Capitol Building, where the United States Congress proposes economic policy such as tax rates. Image courtesy of Ed Marshall on Flickr.

Keywords: Social insurance; asymmetric information; social security; moral hazard; EITC.

Session Activities

Readings

Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

  • [R&T] Chapter 15, “Public Finance and Public Choice.”

Lecture Videos

Resources

Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

What is one reason that a consumption tax may be preferable to an income tax?

 

The correct answer is a consumption tax encourages savings (by making consumption relatively more expensive), and it allows the government to discourage the consumption of certain goods (e.g., cigarettes or alcohol). These may be goods that have negative externalities, or goods that we believe people have difficulty in resisting and thus should be discouraged from eating. A consumption tax is also regressive, but we generally believe that this is a disadvantage, not an advantage, of a consumption tax.

Question 2

What is the definition of a targeted government benefit or program?

 

The correct answer is a targeted government benefit or program is only available to those that need the program or households that meet specified criteria. A universal program is available to everyone (the opposite of targeting). A regressive program is one that benefits the rich more than the poor.

Further Study

These optional resources are provided for students that wish to explore this topic more fully.

Other OCW and OER Content

CONTENT PROVIDER NOTES
14.41 Public Finance and Public Policy, Fall 2010. MIT OpenCourseWare An in-depth course on the government’s role in the economy.

« Previous | Next »

« Previous | Next »

Session Overview

In 2010, President Obama signed the Patient Protection and Affordable Care Act (PPACA) into law to address issues of access and cost in healthcare. In this lecture, we discuss these issues in healthcare and the role of the PPACA in addressing these issues to demonstrate how a public policy tool can be used to address many of the economic problems discussed throughout the course.

The overuse of medical services is a key problem in healthcare. Image courtesy of University of Nottingham on Flickr.

Keywords: Healthcare; medical costs; medical insurance; PPACA; moral hazard.

Session Activities

Lecture Videos

Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

Which of the following is NOT a feature of the PPACA?

 

The PPACA requires all individuals to be covered by a healthcare insurance policy to fix the adverse selection problem and allow insurance companies to price insurance fairly. In turns, it forbids insurance companies from discriminating in health insurance costs. Furthermore, to guarantee that everyone can afford insurance, it provides subsidies for low income individuals.

Question 2

Which of the following is an example of the moral hazard resulting from health insurance coverage?

 

Individuals covered by health insurance are more likely to engage in risky behaviors since they dont bear the financial cost of injury. Furthermore, individuals are more likely to use medical services, and healthcare providers are more likely to provide more medical care than necessary.

Further Study

These optional resources are provided for students that wish to explore this topic more fully.

Additional Readings

The following article was referenced in lecture:

Gawande, Atul. “The Cost Conundrum.” The New Yorker, June 1, 2009.

To learn more about healthcare reform, check out Professor Gruber’s graphic novel:

Gruber, Jonathan. Health Care Reform: What It Is, Why It’s Necessary, How It Works. Hill and Wang, 2011. ISBN: 9780809053971.

« Previous | Next »

« Previous | Next »

Preparation

The problem set is comprised of challenging questions that test your understanding of the material covered in the course. Make sure you have mastered the concepts and problem solving techniques from the following sessions before attempting the problem set:

Problem Set and Solutions

Problem Solving Video

No Problem Solving Videos are available for problem set 9.

« Previous | Next »

« Previous | Next »

Session Overview

The majority of government revenue earned is not spent on explicitly redistributive programs, such as those discussed in previous lectures about efficiency and equity. In fact, the majority of government revenue earned is devoted to social insurance. Social insurance is designed to insure individuals against risk in cases where the private market may not effectively provide such insurance. In this lecture, we will begin to learn about the role of social insurance.

Social Security, launched in 1935, is a US social insurance program. Image courtesy of wisaflcio on Flickr.

Keywords: Taxation; tax cuts; redistribution methods; categorial cash transfers; social security.

Session Activities

Readings

Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

  • [R&T] Chapter 15, “Public Finance and Public Choice.”

Lecture Videos

Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

What is one potential disadvantage of social insurance programs such as Social Security?

 

The correct answer is that social insurance programs such as Social Security may encourage people to retire earlier than they would have otherwise, and thus removes productive people from the workforce. Social Security is not subject to adverse selection, because it has universal enrollment (and so it is not possible that only those at high risk of disability or early retirement enroll). It is not regressive (in fact, it is progressive). It does insure people from unexpected loss of earning power, but this is the objective of the policy, not a disadvantage.

Question 2

Which of the following behaviors is an example of moral hazard?

 

Moral hazard refers to the phenomenon in which insuring an agent against an adverse event (sickness, car accidents, fires, unemployment) then encourages adverse (i.e., reckless) behavior that may make those events more likely. This can occur in any insurance market.

Question 3

Which of the following behaviors is an example of adverse selection?

 

The correct answer is that people with chronic illnesses are more likely to buy health insurance, because their expected benefit from the health insurance is greatest. Becoming less cautious after purchasing insurance is an example of moral hazard. On the other hand, the fact that younger drivers generally have a greater risk of accidents and thus pay higher premiums is not an example of either moral hazard or adverse selection, but reflects the fact that insurance costs typically correspond to relative risk.

Further Study

These optional resources are provided for students that wish to explore this topic more fully.

Other OCW and OER Content

CONTENT PROVIDER NOTES
14.41 Public Finance and Public Policy, Fall 2010. MIT OpenCourseWare An in-depth course on the government’s role in the economy.

« Previous | Next »

Course Info

Departments
As Taught In
Fall 2011
Level
Undergraduate
Topics
Learning Resource Types
Lecture Videos
Recitation Videos
Problem Sets with Solutions
Exams with Solutions
Exams
Lecture Notes
Exam Materials
Problem Sets
Download Course
MIT Open Learning
Over 2,500 courses & materials
Freely sharing knowledge with learners and educators around the world. Learn more
© 2001–2024 Massachusetts Institute of Technology
Accessibility
Creative Commons License
Terms and Conditions
Proud member of:
© 2001–2024 Massachusetts Institute of Technology