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Chapter 2

Chapter 2 Full Notes

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Boston College
ECON 1131

Chapter 2: Solving the Economic Problem: Efficiency and Equity  Economist assume people are self interested  Two criteria that economists judge solutions: efficiency & equity/fairness Efficiency  Efficiency: people have made the choices that best meet their objectives Efficiency with a Single Objective  “Best meeting objectives” only holds for single objective problems  Only wrinkle in defining efficiency is when the obj. doesn’t have a natural limit- in this case the obj. is maximizing utility or profit  Coming as close to objective as possible Efficiency with Multiple Objectives  When there are two or more objectives, an allocation (set of choices) is efficient if moving closer to any one objective is not possible without moving farther away from at least one other objective  Law of substitution: a test of efficiency with more than one objective that says moving loser to on objective is possible only by moving farther away from at least one other objective o Efficiency, then, best meets multiple objectives in the narrow sense of achieving an absence of slack Limitations of the Efficiency Criterion  The weighting scheme of relative values turns the two objectives into a single objective  Selecting a best strategy among a number of efficient strategies depends on whatever criterion you use to assign weights to the two objectives Equity  The concern for equity in economic analysis has two dimensions: o (1) equity in terms of economic outcomes or end results’ o (2) equity in terms of the process that generated the end results End-results Equity  Acriterion for judging the solution to an economic problem that asks whether the outcomes are fair  How should society value to the losses of the rich against the gains of the poor?  Consumer sovereignty: individuals are best able to judge their own self-interests o Not effective in comparing the gains and losses experienced by different individuals/as individuals perceive them  Efficiency principle applied to individuals: a policy or event is desirable if it makes at least one person better off without making anyone else worse off o Can’t resolve fundamental question of end-results equity because it does not apply to situation involving gainers and losers  Horizontal equity: principle of end results equity that requires that equals receive equal treatment o Only consensus that has arisen in the area of end-results equity Process Equity  Process equity: a criterion for judging economic activity that asks whether the rules under which the economy operates are fair o Associated with Robert Nozick- said any economic outcome is fair as long as the process generating the outcome is fair  Equality of opportunity: a principle of process equity that requires that individuals have equal access to whatever economic opportunities they are willing and able to pursue so that they can develop their economic potential to the fullest  The twin goals of end-results equity and process equity are not entirely independent of one another  Equality of opportunity tends to produce horizontal equity, and the inverse Economists as Model Builders  Controlled experiment: method of analysis for determining the cause-and-effect relationships that studies the effects of changing one element in an environment at a time while holding co
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