(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 637

612 PART 4 • Information, Market Failure, and the Role of Government
TABLE 16.2

FOUR VIEWS OF EQUITY

1. Egalitarian—all members of society receive equal amounts of goods
2. Rawlsian—maximize the utility of the least-well-off person
3. Utilitarian—maximize the total utility of all members of society
4. Market-oriented—the market outcome is the most equitable

The four views of equity in Table 16.2 move roughly from most to least
egalitarian. While the egalitarian view explicitly requires equal allocations, the
Rawlsian puts a heavy weight on equality (otherwise, some people would be
much worse off than others). The utilitarian is likely to require some difference
between the best- and worst-off members of society. Finally, the market-oriented
view may lead to substantial inequality in the allocations of goods and services.

Equity and Perfect Competition
A competitive equilibrium leads to a Pareto efficient outcome that may or may not
be equitable. In fact, a competitive equilibrium could occur at any point on the contract curve, depending on the initial allocation. Imagine, for example, that the initial
allocation gave all food and clothing to Karen. This would be at OJ in Figure 16.8,
and Karen would have no reason to trade. Point OJ would then be a competitive
equilibrium, as would point OK and all intermediate points on the contract curve.
Because efficient allocations are not necessarily equitable, society must rely to
some extent on government to achieve equity goals by redistributing income or
goods among households. These goals can be reached through the tax system.
For example, a progressive income tax whose funds are used for programs that
benefit households proportionally to income will redistribute income from the
wealthy to the poor. The government can also provide public services, such as
medical aid to the poor (Medicaid), or it can transfer funds through such programs as food stamps.
The result that a competitive equilibrium can sustain every point on the contract curve is a fundamental result in microeconomics. It is important because it

suggests an answer to a basic normative question: Is there a trade-off between
equity and efficiency? In other words, must a society that wishes to achieve
a more equitable allocation of resources necessarily operate in a manner that
is Pareto efficient? The answer, which is given by the second theorem of welfare
economics, tells us that redistribution need not conflict with economic efficiency.
Formally, the second theorem states the following:

Recall from §3.1 that an
indifference curve is convex
if the MRS diminishes as
one moves down along the
curve.

If individual preferences are convex, then every Pareto efficient allocation
(every point on the contract curve) is a competitive equilibrium for some initial allocation of goods.
Literally, this theorem tells us that any equilibrium deemed to be equitable can
be achieved by a suitable distribution of resources among individuals and that
such a distribution need not in itself generate inefficiencies. Unfortunately, all
programs that redistribute income in our society are economically costly. Taxes
may encourage individuals to work less or cause firms to devote resources to
avoiding taxes rather than to producing output. So, in effect, there is a trade-off