Friday, December 03, 2004

Economic efficiency, part 1

At last, a post about economics! (There will be many more, I promise).

The stated goal of economic policy is often "economic efficiency". However, an exploration of what "economic efficiency" really means will reveal that "efficient" outcomes can look pretty perverse to anyone with a soul.

Imagine a little valley with an automated factory upstream from a small, poor hamlet. The factory makes $100k a year in profit for its owner, but discharges various kinds of nasty gunk into the stream, which makes the children of the village sick and makes it hard for the old ladies of the village to breathe.

Imagine an economist completely beholden to the concept of economic efficiency. Upon encountering this sad scene, he would ask the villagers "what would you be willing to pay the factory owner in order to be free of this nasty gunk". The answer, of course, will be "not much", since the poor villagers, while they love their kids, don't have all that much money. The economist nods in satisfaction, picks up his briefcase, and leaves the village whistling cheerfully. The current state of affairs yields a total surplus of $100k minus "not much", and is therefore more *efficient* than shutting down the factory.

However, the scene in the next valley is different. There is another automated factory, but *this* factory is upstream from a billionaire's mansion. The billionaire doesn't have any kids, in fact this is his scenic getaway that he doesn't use much, and he doesn't swim in the stream anyway, so he is not actually bothered that much by the gunk. But it does bother him a little. The economist asks the billionaire what he'd pay to have the factory stop producing gunk. The billionaire says "Smithers, what have we got in the petty cash box...? One hundred fifty thousand? That would do. It does get a little smelly some days, and I *do* so love this spot". The economist's eyes widen in horror. The total social surplus of the status quo is 100k for the factory and -150k for the billionaire. The social surplus is negative! Economic inefficiency! This outrage must be stopped!

The point: in the market, the preferences of rich people matter a whole lot more than the preferences of poor people. And at no point in any economics class is this idea ever discussed.

1 comment:

Anonymous said...

That is one of the many reasons why I didn't like my economics class!