At our most basic, economists are trying to solve a complex allocation problem: Given a scarce amount of resources, how do we decide who gets what, when and how?
In solving the allocation problem, most economists focus on allocations of society’s scarce resources that meet the social goal of maximizing the well-being of society. Because it is assumed that well-being is highly correlated with economic value, the social goal of maximizing well-being is often translated to mean maximizing the total economic value (or productivity) of society. If we maximize the value from the scarce resources then an allocation is thought to be efficient. An allocation is inefficient if a different allocation can be found such that the total value to society is higher using the same amount of society’s scarce resources.
Read on...
Efficiency give us a somewhat judgment-free way of measuring whether we are getting the most out of our scarce resources. We say that efficiency is a somewhat judgment-free way of measuring a solution to the allocation problem because we recognize that setting a goal of getting the maximum value to society out of scarce resources is a judgment. What we mean by judgment-free is that by focusing on maximizing the total value to society we are not making a judgment about whom should get what part of that total value. An allocation is either efficient or inefficient. If an allocation is inefficient, then we can look for a different way to allocate our scarce resources that provides greater benefit using the same amount of resources (or the same benefit using fewer resources).
But a focus on efficiency says nothing about how that pie is divided between members of society. There are many ways to slice a pie and not shrink the size of the pie. So is efficiency all it's cracked up to be? Is efficiency fair?
When talking about how the economic pie is divided, we have to talk about equity. Efficiency is about whether we are meeting our goals using the least amount of resources. Equity is about who gets what. Equity is a statement about the fairness of an allocation. But the definition of what is fair will be different depending on who is making the decision.
In deciding how best to allocate our scarce resources, there thought to be a trade-off between equity and efficiency. As Greg Mankiw puts it in his Principles of Microeconomics textbook:
Another trade-off society faces is between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society's members...When government policies are designed, these two goals often conflict...In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.
I agree with Mankiw, to an extent; given the social goal of maximizing the size of the economic pie, a policy that aims at equity creates incentives inconsistent with the goal. But what is missing from this discussion and what is implicitly assumed in Mankiw's definition of efficiency is that everyone is OK with the goal of maximizing the size of the economic pie. Efficiency does not imply the goal of maximizing total economic productivity; to the contrary, maximizing total economic productivity is the subjective goal to which the objective definition of efficiency is being applied.
This distinction is important because it is often assumed that there is a one-to-one correspondence between total economic productivity and total societal well-being or happiness. Therefore to improve societal well-being, concerns of equity must be thrown away since total economic productivity can only be maximized through efficiency. Hence the trade-off. But what if there is not a one-to-one correspondence between happiness and total economic productivity? Does that render the concept of efficiency--and consequently economics--useless?
Quite the contrary and this is where some of the critics of economics overreact when they see Mankiw-like definitions of efficiency. Efficiency is usually defined with the underlying social goal of maximizing total productivity. But what if society values equality? That is, what if total productivity is only part of what determines well-being and people actually care about the distribution of resources--at least minimally.
The trade-off that is typically discussed between equity and efficiency is really a trade-off between equity and total economic productivity. The logical problem comes in assuming that total economic productivity and total well-being are the same. But what if part of our societal goal is some concept of equity? Can we still achieve it efficiently? According to this definition of efficiency-- achieving a defined social goal using the least amount of society's resources as possible—yes, we can still achieve any societal goal efficiently if we allocate resources to align with the stated goal. Efficiency doesn't have to be predicated on the particular goal of maximizing total economic productivity. The social goal may be total economic productivity, or it may be any one of a million other distributions of social well-being. No matter the goal, economics provides a valuable set of tools for understanding how to achieve those goals using the least amount of society's resources--and thereby freeing those resources for other uses (or nonuses).
