EQUITY and EFFICIENCY

1. 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

2. 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.

3. 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.

4. 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.

5. 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

6. 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.

7. 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.

8. 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?

9. 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.

10. 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

11. 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.

12. 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

13. 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

14. 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

15. Life cycle page 258

16. 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).

17. 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.

18. 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).

19. 10 3.2 20 7.3 30 12.3 40 18.7 50 26.4 60 35.4 70 47.2 80 60.1 90 76.1 100 100

20. 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

21. % INCOME % Income 100 90 80 70 60 50 40 30 20 10 0 Decile Households 10 20 30 40 50 60 70 80 90 100

22. CUMULATIVE % INCOME Cumulative% Income 100 90 80 70 60 50 40 30 20 10 0 Decile Households 10 20 30 40 50 60 70 80 90 100

23. LORENZ CURVE 45* line represents equality of income Cum % income Lorenz curve measures inequality of income distribution % households

24. LORENZ CURVE If Lorenz curve moves outwards then income distribution has become more unequal Cum % income In this case, the Gini coefficient (area between Lorenz curve and equality line) has become greater % households

25. Lorenz Curve

26. Gini Coefficient

27. 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.

28. 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

29. 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

30. Equity and Taxation • Progressive taxation leads to an increase in equity. • Regressive taxation will lead to a fall in equity.

31. 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)

32. 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.

33. 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.

34. 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.

35. 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

36. EQIUTY/EFFICIENCY TRADE OFF 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. EFFICIENCY A B EQUITY

37. LOSS OF EFFICIENCY Disincentives to work or take risks Compliance costs increase Progressive income taxes Transfer payments Disincentives to work No clear price signals for resource allocation Public provision Minimum wages May creates disequilibrium in the labour market