Chapter 3

Efficiency and Equity

In chapter 1 we studied a Vickrey auction involving Mara and six friends. We
concluded that the Vickrey auction set a price such that the sum of the welfare
of consumers and the welfare of the seller is maximized, and that there was no
other allocation that makes society better off. We concluded that this seems to
be a desirable state of affairs. And of course it is: we would surely like
everything in the world to be arranged so as to make society as well off as
possible.
Unfortunately, make society as well off as possible is too vague an
instruction to be of any practical use. Economists, being practical people, have
developed a far more useful guide as to how the world should be organized.
The guide rests on two distinct ideas efficiency and equity that form the
basis of how economists evaluate the desirability of different outcomes and
different policies.
In this chapter, we study the concepts of efficiency and equity separately, and
in that order. Doing it this way is not simply a matter of didactic convenience.
Economists not only teach these ideas separately and in that order, they also
work in this way. To see why this is the case, consider the problem of
providing pizza to two of your friends, whom (seeing as I dont know them) I
shall call Greg and Elaine. For the sake of argument, let us assume that Greg
and Elaine love pizza and never stop being hungry. One way to approach the
problem is to divide it into two tasks. First, make the pizza as large as possible.
No matter what sharing scheme you devise for any given pizza, you can always
make both Greg and Elaine better off by increasing its size and giving both of
them a little more. Only after you have made the pizza as large as you can do

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you tackle the second task of deciding how to split it between your friends.
The concepts of efficiency and equity are analogous to these two tasks. An
efficient outcome is one that has made the pizza as large as possible. An
equitable outcome is one that allocates the pizza to Greg and Elaine in a way
that seems fair. Obviously, one could have an efficient outcome that that is
entirely inequitable, and one could have an equitable outcome that is grossly
inefficient. The socially optimal outcome is one that is both efficient and
equitable.

1. Efficiency
Economists have a particular kind of efficiency in mind, called Pareto
efficiency.1 It is defined as follows:
A Pareto efficient outcome is one that cannot be changed so as to make
someone better off without also making someone else worse off.
As a natural corollary,
A Pareto improvement is a change that makes at least one person better
off without also making anyone else worse off. Any outcome that we can
change to yield a Pareto improvement is said to be Pareto inefficient.
When economists use the words efficient or inefficient alone, they mean
Pareto efficient or Pareto inefficient.
My wife tells me that I am inefficient at sweeping the floor. But she is wrong. I
think what she means2 is that I am slow and incompetent, and that I leave
parrot feathers under the bird cage. She is quite correct, but this does not mean
I am inefficient. To the contrary, there is no way for me to do a better job
(thereby making my wife happier) without making myself worse off. The

Named for Wilfredo Pareto (1848-1923), an Italian economist whom you need know nothing
about.

Sometimes its better not to ask.

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feathers under the bird cage, annoying as they are to my wife, are part of a
state of affairs that constitutes a Pareto efficient outcome. Ergo, I am an
efficient sweeper. Of course, in my assessment of my sweeping prowess, I am
ignoring equity. My personal tradeoff of feathers against relaxation time may
not pay a fair amount of attention to my wifes preferences for a clean floor.
But equity is a separate issue that well get to later.
Being efficient is not the same as making society as well off as possible. But
this does not make efficiency an empty concept. To the contrary, it is very
powerful. If any current state of affairs is not Pareto efficient, the policy
implication is straightforward: devise a policy to attain a Pareto improvement.
Sadly, Pareto improvements are often hard to come by.
The only way to give Greg more pizza without taking it away from
Elaine is to provide a larger Pizza. But, in practice, you will have to pay
more for a larger pizza, so you are worse off. If you dont buy a larger
pizza, then making Greg better off requires that you make Elaine worse
off.
The only way for my wife to enjoy a cleaner floor without making me
worse off is to discover a new technique that allows me to sweep better
with no more effort than I already expend. We havent come up with such
a magic bullet yet.
In chapter 2 we saw that that under some special assumptions -- that
everyone is indifferent between the escalator and the stairs, and that the
stairs will never get congested then slowing down the escalator could
save electricity without making anyone worse off. Unfortunately, these
special assumptions are not likely to be met. The stairs are likely to get
more congested, so everyone who was using them already will be made
worse off. At the same time, people with heavy bags who had a strict
preference for the escalator will continue to use it and be made worse off
by its reduced speed.

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But these examples do not mean that Pareto improvements are impossible to
find. Here are two real-world examples:
Gas Royalties. The Federal government sells leases for offshore oil wells to the
highest bidder. The oil company then pays a royalty per barrel of oil, usually
about 16 percent. As the well gets old, the cost of extraction rises, and when
the extraction cost exceeds the price of oil net of the royalty, the well shuts
down. For example, if the price of oil is $40 per barrel, the royalty will be
$6.40, leaving a net income to the company of $33.60 per barrel. Hence, if the
extraction cost rises above $33.60, the well closes down.
Closing down the well once the extraction cost reaches this level is inefficient.
The value of the oil still exceeds the extraction cost, while the government
gets nothing when the well closes. One solution might be to charge a royalty
that declines once the extraction cost rises sufficiently. Unfortunately, this
provides an incentive for the firm to exaggerate its cost, and the government
would have to get involved in the difficult and expensive task of auditing the
cost of each and every well. A better solution is to lower the royalty rate on
old wells, because it is impossible for the firm to exaggerate the age of the well.
Then, whenever oil can still be produced from an old well at a cost below its
market value, the firm can earn some profits and the government still gets
some royalties. Both the firm and the government are made better off by
continuing to operate these older wells, which is a Pareto improvement.
Tradable SO2 emissions permits. Beginning in the 1970s, the US Federal
government introduced regulations designed to reduce emissions of sulfur
dioxide (SO2), especially from power plants. These regulations typically took
the form of maximum emission levels common for all plants that effectively
required every power plant to install expensive scrubbers or to switch to low
sulfur-coal. The problem was that the installation of scrubbers was more
expensive for some plants than for others. At the same time, some plants were
located closer to sources of low-sulfur coal, and therefore could use it at lower
cost. Plants with the most expensive compliance costs were forced to close

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down, while plants with low compliance costs, which could have sustained an
even greater reduction in emissions, reduced their SO2 output only by the
minimum required of all plants.
In 1990, the government introduced a tradable permit system. Each plant was
allocated permits to emit a certain quantity of SO2, but they were then allowed
to buy or sell these permits. Plant with low abatement costs reduced their
emissions by more than they needed to and sold their excess permits. Plants
with high abatement costs reduced their emissions by less than their permits
required, but then bought extra permits from other firms.
Both high-cost and low-cost plants were made better off by the switch from
uniform standards to tradable permits. The total quantity of permits issued left
aggregate SO2 emission unchanged. High-cost plants paid less for a permit to
emit an extra ton of SO2 than it would have cost them to reduce their
emissions by a ton, and low-cost plants earned more by selling a permit to
emit a ton of SO2 than it cost them to reduce their emissions by the same
amount. As profits increased for both types of plants without causing a
deterioration in environmental standards, the tradable permit policy turned
out to be a Pareto improvement over the previous policy.
It is useful to think about what sorts of changes are Pareto improvements and
what are not by means of a diagram. Figure 1 plots a new curve called the
utility possibility frontier for two individuals. It traces out the maximum
amount of utility that can be earned by individual A given the amount of
utility that is earned by individual B. Equivalently, it traces out the maximum
utility that B can earn given any level utility earned by A. Imagine, for
example, that we are trying to allocate slices of pizza between A and B. As we
increase Bs utility by giving him more pizza, we must make As utility lower
by taking pizza away from her. One might think of the utility possibility
frontier like a budget line, only it is expressed in terms of utility rather than
quantities of goods. Like a budget line, the utility possibility frontier always
has a negative slope.

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Utility of B

Figure 1 also plots some particular allocations. Consider first, allocation x,

which lies inside the utility possibility frontier. Clearly, it is possible to make
both A and B better off by changing to an allocation that lies on the frontier
and to the northeast of x. That is, any allocation along the segment ab of the
frontier will make at least one of the two better off without making the other
worse off. It follows that x is Pareto inefficient, and moving from x to
anywhere on the segment ab is a Pareto improvement. Point x is equivalent to
leaving some pizza on the plate. We have a pizza large enough to increase
consumption (and hence utility) of both A and B, but at allocation x we are
not using it all.

Utility possibility frontier

a

b
y

Utility of A

FIGURE 1. Allocations and the utility possibility frontier

Now consider allocation y, which lies on the frontier. It is not feasible to move
in a northeasterly direction because that would move us outside the frontier.
The only way to make B better off while satisfying the constraints of the
utility possibility frontier is to make A worse off. Similarly, A can be made

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better off only by making B worse off. Consequently, allocation y is Pareto

efficient.
In fact, any allocation that lies on the utility possibility frontier must be Pareto
efficient, because it would never be possible to make A better off without
making B worse off. At the same time, any allocation that lies inside the
frontier must be Pareto inefficient because it is always possible to make both
better off by moving towards the frontier in a northeasterly direction. Note
that, although there always exist some efficient allocations that are Pareto
improvements over any inefficient allocation, moving from an inefficient
allocation to any efficient allocation need not be Pareto improving. For
example, moving from inefficient x to efficient y makes B worse off, so it
cannot be a Pareto improvement.
Compensation criteria. Pareto improvements are always desirable. But many
times, the Pareto improvement criterion for policy provides no insights about
whether a policy change is desirable. For example, as a society we may prefer
efficient allocation y to inefficient allocation x, but moving from x to y is not a
Pareto improvement. We may also prefer a more egalitarian allocation b to the
allocation y, but moving from y to b is also not a Pareto improvement. Under
such circumstances, we need a more discriminating criterion for deciding
between competing allocations.
Two versions of an ethical criterion to use when there are losers as well as
gainers were introduced by Nicholas Kaldor (1939) and John Hicks (1939).
Collectively they are known as the compensation criteria, and they are defined
as follows:
Kaldor criterion. Implement a policy if, with the policy change, it is
possible to fully compensate the losers while still leaving the gainers
better off.
Hicks criterion. Implement a policy if the potential losers cannot
compensate the potential winners for not having the policy change, while

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still leaving themselves better off than they would be with the policy
change.
The criteria do not require that compensation actually be made; it only needs
to be hypothetically possible to make the compensating payments.

Utility of B

Figure 2 provides a graphical illustration of the compensation criteria.

Consider a government thinking about whether to undertake a project that
involves a movement in the allocation of utilities from x to y. This makes B
worse off and A better off. The Kaldor criterion asks whether, after the project
is implemented, A can compensate B for his losses, perhaps by making a cash
payment, so that both A and B are better off with the project than they are
without. That is, can we use the project to move us from x to y and then devise
some compensation payment to attain an allocation of utility at a point such as
z? The Hick criterion asks whether B could bribe A to forgo the project. That
is, starting from x, can B offer a cash payment to A to that both A and B are
better off without the project. This would require that a payment is made that
allows A and B to attain an allocation such as w.

z
x
w
y

Utility of A

FIGURE 2. Compensation criteria

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Utility of B

The compensation criteria help us make decisions about projects and policies
when the concept of Pareto improvement provides no guidance. Both criteria
always rank a Pareto efficient distribution of utility over a Pareto inefficient
distribution. Figure 3 illustrates a prospective policy that could move society
from x to y. Allocation x lies inside the utility possibility frontier and is
inefficient, while y lies on the frontier and so is efficient. After moving from x
to y, the frontier tells us that we can always redistribute utility to get to z,
where both are better off than at x. Thus, by the Kaldor criterion, a policy that
moves us from x to y is desirable. If we stay at x, B cannot bribe A not to have
the project, because this would require attaining a point such as w, which is
not feasible. Thus, by the Hicks criterion, the policy is desirable.

z
x
w
y

Utility of A

FIGURE 3. Compensation criteria rank efficient policies over inefficient policies

The compensation criteria help us because they justify moves from inefficient
allocations to efficient allocations, even when they are not Pareto
improvements.
Unfortunately, there are situations when the compensation criteria do not
help us. As Figure 4 illustrates, they cannot help us when both x and y are
efficient. If the initial distribution is x and the post-policy distribution is y,
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Utility of B

then we cannot attain a distribution such as z with the policy, and the Kaldor
criterion fails. In contrast, we cannot attain a distribution such as w without
the policy and the Hicks criterion therefore recommends a movement from x
to y. Thus, the two criteria give different answers, and we cannot reliably
justify a policy (or decided against a policy) that moves us from x to y. When
two allocations are Pareto efficient, they are non-comparable by the
compensation criteria.

z
x
w
y

Utility of A

FIGURE 4. Compensation criteria cannot rank two efficient policies

The compensation criteria also cannot rank two Pareto inefficient allocations,
as Figure 5 illustrates. In this case, if we begin at x, the Kaldor criterion
indicates that we should move to y, because then a transfer could be made to
attain z. But the Hicks criterion indicates that we should not move to y,
because it would be possible to for A to bribe B, attaining w and leaving both
better off. A similar problem arises if we consider a movement from y to x.
When two allocations are Pareto inefficient, they are also non-comparable by
the compensation criteria.

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Utility of B

z
x
w
y

Utility of A

FIGURE 5. Compensation criteria cannot rank two inefficient policies

So, in summary:
A policy that yields a Pareto improvement is always desirable.
A policy that moves us from any Pareto inefficient allocation to any
Pareto efficient allocation is always desirable under the compensation
criteria,
The compensation criteria cannot compare two Pareto efficient or two
Pareto inefficient allocations.
Even when the compensation criteria work, compensation is only
hypothetical. If we know that compensation is not actually going to be
made, do we really want to make a move that makes people worse off?
To address these last two concerns, we need to develop some tools to think
about how as a society we might feel about inequality. This we turn to next.

2. Equity
I understand that some people in this country think otherwise, but Kobe
Bryant and Shaquille ONeal seem pretty much the same to me. So if you ask
me whether I prefer that Kobe earns $10 million a year and Shaq $5 million or
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earning levels that are reversed, Ill tell you Im indifferent. If you ask me
whether I would prefer that Bill Gates keeps his money while Joe Homeless
gets $1,000 a year, or Joe Homeless and Bill Gates swap positions, Ill also be
indifferent, unless of course I am Joe Homeless.
So ask me a serious question. How much of Bill Gates money would I be
willing to take away in order to give Joe Homeless extra income of, say,
$1,000? Id like to help Joe, and Im willing to hurt Bill to do it. I would
certainly be willing to take a $100 from Bill to give $1,000 to Joe. In fact, that
would make me happier than the status quo. Id certainly be willing to take
$1,000 from Bill and give it Joe. Id even be willing to take $10,000 from Bill if
that meant Joe could have $1,000 more. Whats the maximum amount I would
be willing to hurt Bill in order to make Joe better off? Im not sure, because I
have not thought hard enough about it. However, whatever the amount is, it
must be just that amount that leaves me indifferent between the new income
distribution and the status quo.
These various distributions are plotted in Figure 6, which compares utilities
rather than income. The figure plots an indifference map. This map is similar
in principle to the individuals indifference curves that we studied in chapter
2. However, whereas the indifference map in chapter 2 illustrated one persons
preferences about the consumption of two goods, the map in Figure 6
illustrates my preferences about the relative wellbeing of Bill and Joe. If my
preferences are a good reflection of what society as a whole prefers, then this
indifference map illustrates societys attitudes to inequality. Such an
indifference map is known as a social welfare function.
The status quo is indicated with Bill earning lots of dough and Joe having very
little. Taking a little from Bill to give a lot to Joe implies a movement from s to
a. Society prefers a to s, so a is on a higher indifference curve. The maximum
amount we would be willing to hurt Bill in order to give Joe the same increase
in utility as moving from s to a is the amount that leaves society indifferent
between s and the new allocation, indicated by b. Any further damage to Bill,

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Bills Utility

say by moving to c, is less preferable from societys perspective, so this puts us

on a lower indifference curve.

Status quo
s

b
c

Joes Utility

FIGURE 6. The social welfare function

The indifference map that plots out the social welfare function says nothing
about our ability to trade off Bills happiness for Joes happiness. To compare
our preferences about inequality with our ability to make adjustments, we
need to superimpose the social welfare function on our utility possibility
frontier. Figure 7 does so, and illustrates that the best society can do is to select
point d, where an indifference curve is tangential to the utility possibility
frontier. That is, the most preferred allocation of utilities will always be a
Pareto efficient allocation.
Society is indifferent between a and d, but a is not attainable. Society can
attain both d and e, both of which are Pareto efficient. but d is strictly
preferred to e. Thus, once we know what the social welfare function looks
like, we can rank efficient allocations that the compensation criteria cannot
rank. Similarly, we can see that b is preferred to c, even though both are
Pareto inefficient. Thus, the social welfare function also allows us to rank pairs
of inefficient allocations.

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Bills Utility

The compensation criteria suggested that we should always choose a policy

that moves us from an inefficient allocation to an efficient allocation.
However, if the compensation is not actually paid, society may not prefer such
a move. For example, a policy that moves us from b to f in Figure 6 would be
recommended by the compensation criteria, but f is clearly inferior to b. This
example teaches us that we must be careful about our use of compensation
criteria. However, if we were to move to f by means of a policy change, the
utility possibility frontier tells us that we could subsequently do better by
changing the allocation of utility from f to d.

s
a
d
b
e
c
f
Joes Utility

FIGURE 7. Socially optimal choices

The shape of the social welfare function. Figures 6 and 7 draw a social welfare
function in which the indifference curves become flatter as we move from left
to right. The reason for such a shape is intuitive. When Bill is rich and Joe is
poor, we are willing to take a substantial sum from Bill to make Joe a little
better off. Hence the curves are very steep at the left. But when Joe is already
rich and Bill poor, the situation is reversed, and the indifference curves
become very flat.
Although this is the general shape that we expect the social welfare function
to have, we are in a more difficult position if we want to discover the exact

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shape and location of the indifference curves for a particular problem. They
are not directly observable, so we cannot just go out and measure them.
Perhaps we could go out and ask people what their preferences are, add
everyones preferences up in an appropriate way, and thereby construct the
social welfare function from these survey data. There are a number of
problems with this. The first is that it would be exorbitantly expensive. The
second is a more profound conceptual problem. People would state very
different preferences about the distribution of utility if they are one of the
people being affected. For example, if I were Joe Homeless, I would be strongly
in favor of a massive redistribution of wealth away from Bill Gates and toward
me. If I were neither Bill nor Joe, I would undoubtedly favor a more modest
redistribution.
Which of these stated preferences about equity is the correct one? The
philosopher John Rawls (1971) has suggested that neither is correct. He argued
that our preferences should be elicited under what he termed a veil of
ignorance. We should ask people to imagine a situation in which they know
that they could become Bill Gates or that they could become Joe Homeless.
Then, given that they could be either one of these people, what sort of
distribution would they prefer? Of course, people are not behind this veil of
ignorance and so Rawls suggestion does not really get us anywhere. Rawls was
aware of this, so he went one step further. He ventured the answer that people
would give if they were truly behind a veil of ignorance. He argued that
people in this situation would favor a distribution scheme that leaves the worst
off person as well off as possible. Obviously, few governments have
implemented policies based on Rawls ideas.
Perhaps another scheme to discover the social welfare function is to allow
people to vote on alternative polices and thereby reveal societys preferences
through the ballot box. Unfortunately, democracy does not work well either.
First, voting does not avoid the self-interest problem that Rawls was grappling
with. But voting introduces yet another problem. Consider a vote for three

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different tax policies A, B, and C, each of which impose different rates of

income taxes on the poor, the middle class, and the rich. The population is
evenly divided between the three income levels. Policies are offered in pairs,
and the voting rule is to choose the policy that the majority prefers. Table 1
summarizes the options:

TABLE 1. Alternative tax proposals

A

Poor

25%

27%

30%

Middle class

31%

27%

30%

Rich

33%

36%

30%

The poor prefer A because they pay less in taxes. Similarly, the middle class
prefers B while the rich prefer C. A majority (poor and middle class) prefers B
to C, a majority (poor and rich) prefer A to B, and a majority (middle class and
rich) prefers C to A. So, if we were to start with any policy, a majority would
prefer to change policy. For example, if the status quo was policy A and policy
C were offered as an alternative, the middle class and the rich would vote for
a switch to C. Once at C, however, a majority would now vote for a switch to
B. Finally, once we implement policy B, the poor and rich would vote for a
switch to A! Our voting scheme creates an endless cycle of votes indicating a
preference to switch.
Is this outcome a peculiarity of the voting scheme adopted? The answer,
unfortunately, is no. In an astounding paper published over 50 years ago,
Nobel laureate Kenneth Arrow (1951) proved what has become known as the
Arrow impossibility theorem. He started out with a short list of five desirable

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properties of any voting scheme.3 Arrow then proved that there is no voting
scheme including voting schemes yet to be invented! that satisfies these
desirable properties.
We do not have the math tools necessary to prove Arrows remarkable
theorem. Table 1 gave an instance of the implications of the theorem: we
devised a voting scheme and found an example in which it fails to produce a
preferred outcome. Arrows theorem tells us that any voting scheme you care
to think of will also fail at some point.

3. Concluding comments
Economists are enamored of the concept of Pareto efficiency for good reason.
If the current situation is not Pareto efficient, we know immediately that we
can make at least one person better off without making anyone else worse off.
Obviously, this is a desirable thing to accomplish, so the first task for economic
policymakers is to keep a sharp lookout for Pareto inefficient situations, and to
devise a Pareto improving policy whenever one is found.
The economists task becomes much harder when Pareto improvements are
not available. To tackle these issues, economists developed, first, the concept
of compensation criteria and, second, the more satisfactory concept of the
social welfare function. We analyzed these with the help of the utility
possibility frontier.

They are: 1) (Unanimity): if everyone prefers option A to option B, then the voting scheme
should rank A above B. 2) (non-dictatorship): the outcome is not completely determined by
the preferences of one individual, 3) (Transitivity): if A is preferred to B and B is preferred to
C, then A should also be preferred to C. 4) (Independence of irrelevant alternatives): if A is
preferred to B, and B is preferred to C, then A should be preferred to B whether or not option
C is available. 5) (Completeness): the voting scheme should be able to compare all possible
alternatives.

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Because we cannot measure them, the utility possibility frontier and the social
welfare function are more useful as a conceptual framework than they are as
an empirical tool. Nonetheless there are some useful lessons to be learned from
them. One is positive: when a policy changes a Pareto inefficient situation to a
Pareto efficient situation, this is always good for social welfare as long as
compensation is made to the losers.
The other lessons speak more to the limitations of economic analysis. When
the current situation is already Pareto efficient, or when compensation is not
paid to the losers, we cannot say if a proposed policy is desirable without
knowing what the social welfare function looks like. However, there is no
foolproof way for economists or anyone else to identify societys preferences
about different distributions. While economics can still tell us in these
situations what the consequences of different policy choices will be, it cannot
reliably inform us which of the choices is the best.
Because selecting among different policies on equity grounds is fraught with so
much difficulty, economists sensibly restrict their focus to the efficiency
consequences of policy. If the status quo is inefficient and an efficient policy
can be identified, we know that it is in principle possible to fully compensate
the losers from the policy change and still leave those who gain better off.
Whether society actually makes that compensation is a matter for the political
process to decide. The Arrow impossibility theorem, of course, tells us that the
political process is no more likely to choose the best policy than economists
are, but wed rather that politicians be blamed for bad decisions.
It is well known that the vast majority of economists are in favor of free trade.
Critics contend that economists are obsessed with money, and that they have
no empathy for the many people who may lose their jobs and their livelihood
from allowing unfettered imports. These critics are revealing their ignorance
of economists and economics. Economists generally favor unrestricted free
trade because, as we will see later, it makes the economic pie as large as
possible. That means that it is possible for those who gain from free trade to

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fully compensate those who lose, and thereby leave everyone at least as well
off as before. Economists are fully aware that if compensation is not paid, then
we can no longer say that the move to free trade is an improvement. But
economists dont get to decide how the economic pie is divided. Politicians
choose not to make the compensation payments and the public vote against
the tax increases necessary to finance them. Surely they are the ones to blame
when people are made worse off by policy changes that make the economic
pie larger.

Concepts introduced in this chapter

Pareto efficiency

Pareto improvement

efficiency

equity

utility possibility frontier

social welfare function

Hicks compensation criterion Kaldor compensation criterion

Arrow impossibility theorem

Rawls' veil of ignorance

Problems
1. You have 8 units of a good to allocate between two individuals, A and B. Their
marginal utilities are as follows:
Units of Good
1
2
3
4
5
6
7
8

MARGINAL UTILITIES
Person A
Person B
10
15
10
10
8
7
7
5
5
1
3
1
2
0
1
0

(a) For each of the following pairs of utilities, indicate whether it is efficient,
inefficient, or infeasible.

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A = 40, B= 37; A = 35, B = 32; A = 28, B = 37; A = 10, B = 39

(b) If social preferences are Rawlsian (that is, society prefers to make the worst
off person as well off as possible), what should the allocation be?
(c) If society does not care about equity, and is only concerned with maximizing
the sum of all utilities, what should the allocation be?
2. Table 1 in the main text showed a set of tax proposals that generated cycles in
voting. Assess whether the following sets of proposals would also generate cycles.
(a) Alternative tax proposals
A

Poor

25%

27%

30%

Middle class

27%

28%

30%

Rich

33%

36%

30%

(b) Alternative tax proposals

A

Poor

17%

18%

16%

Middle class

20%

22%

24%

Rich

28%

24%

26%

References
Arrow, Kenneth J. (1951): Social Choice and Individual Values. PhD Dissertation,
Columbia University.
Kaldor, Nicholas (1939): Welfare propositions in economics, The Economic Journal,
49:294-300.
Hicks, John (1939): The foundations of welfare economics, The Economic Journal,
49:696-712.

Rawls, John (1971): A Theory of Justice. Cambridge, MA: Belknap.

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