Equity-Efficiency Tradeoff

What Is an Equity-Efficiency Tradeoff?

An equity-efficiency tradeoff is when there is some kind of conflict between maximizing economic efficiency and maximizing the equity (or fairness) of society in some way. When and if such a tradeoff exists, economists or public policymakers may decide to sacrifice some amount of economic efficiency for the sake of achieving a more just or equitable society.

Key Takeaways

  • The equity-efficiency tradeoff is when there is some conflict between maximizing pure economic efficiency and achieving other social goals.
  • Most economic theory uses a utilitarian approach as its ethical framework, but this may conflict with other moral values that people hold, leading to an equity-efficiency tradeoff.
  • Inequality and the redistribution of income is a common example of an equity-efficiency tradeoff.

Understanding the Equity-Efficiency Tradeoff

An equity-efficiency tradeoff results when maximizing the efficiency of an economy leads to a reduction in its equity—as in how equitably its wealth or income is distributed.

Economic efficiency, producing those goods and services that provide the most benefit at the lowest cost, is a primary normative goal for most economic theories. This can apply to an individual consumer or a business firm, but mostly, it refers to the efficiency of an economy as a whole at satisfying the wants and needs of the people in the economy.

Economists define and attempt to measure economic efficiency in several different ways, but the standard approaches all involve a basically utilitarian approach. An economy is efficient in this sense when it maximizes the total utility of the participants.

The concept of utility as a quantity that can be maximized and summed up across all people in a society is a way of making normative goals solvable, or at least approachable, with the positive, mathematical models that economists have developed. Welfare economics is the branch of economics most concerned with calculating and maximizing social utility.

A conflict (and tradeoff) between efficiency and equity can occur if the members of society—or the policymakers who decide how a society operates—prefer other moral or ethical systems over pure utilitarianism. When people decide that other moral values or rights outweigh pure utility maximization, societies often pursue policies that do not lead to maximum social utility in favor of these other values.

The equity-efficiency tradeoff is often associated with normative economics, which emphasizes value judgments and statements of “what ought to be.”

Examples of the Equity-Efficiency Tradeoff

If the utility that one individual gains by poking another person in the eye is greater than the suffering caused, then a purely utilitarian approach would permit or even encourage the eye poking to maximize total social utility. However, almost all people would agree that this violates basic morality and leads to an inequitable outcome for the eye-poking victim.

In a more complicated example, it is often the case that the greatest economic gains—and thus the greatest total utility—occurs when the most successful businesses and entrepreneurs earn higher incomes than others, to encourage more productive behavior. However, this may lead to very unequal incomes. When this happens, policymakers may decide that it is better for society to redistribute some income from higher- to lower-income individuals for the sake of fairness, even though this might reduce the utility of the high-income earners or even society as a whole.

This is the most common form of the equity-efficiency tradeoff, though it also can involve the production, distribution, and consumption of all kinds of goods and services rather than just incomes.

Why Do Equity-Efficiency Tradeoffs Occur?

Maximizing economic efficiency and ensuring the equal distribution of resources seldom go hand in hand, making equity-efficiency tradeoffs fairly common. There are arguments that economic gain doesn’t necessarily have to come at the expense of greater inequality. However, in most capitalist societies, that is precisely what happens.

What Is More Important: Equity or Efficiency?

Both are important, though they cannot always be achieved simultaneously. Most economies generally strive to get the maximum benefits from the resources at their disposal, which seems like a no-brainer. The issue is making sure those benefits are distributed fairly among all people in society.

It’s tricky to keep everyone happy, and opinions vary about which of the two, equity or efficiency, should take precedence—assuming, of course, that they cannot co-exist harmoniously.

Can Equity and Efficiency Be Achieved Simultaneously?

It is a common assumption that greater equity comes at a cost of less economic efficiency. That isn’t necessarily the case, though. For example, the Nordic model, a set of economic standards loosely followed by Sweden, Norway, Finland, Denmark, and Iceland, has given the world an example of how free-market capitalism and a generous welfare system can co-exist harmoniously. Such a system works mainly because these countries have a culture of collectivity, and taxpayers’ money is spent in a way that benefits all.

Article Sources
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  1. Princeton University, OpenScholar @ Princeton. “The Concept of ‘Efficiency’ in Economics.”

  2. Iqbal, Razi, and Todi, Padma. “The Nordic Model: Existence, Emergence, and Sustainability,” Procedia Economics and Finance, vol. 30, 2015, pp. 336–351.

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