Equity and Efficiency: The Biggest Puzzle
While economists like to think they have the answer to many, if not all, of the problems facing the world, there is one area that most economists have been cautious of entering as economists. That is the problem of finding equity within efficient solutions to problems, or efficiency within equitable solutions to problems. Inconsistency between efficiency and equity is the conundrum of our profession, and probably one of the biggest obstacles to the acceptance of economic suggestions.
The adversarial relationship between equity and efficiency arises in many issues society is currently facing. There is the question of alleviating poverty, potential military drafts, affirmative action programs and the rights of women and minorities, and even of deregulation in the airline, communication and savings and loan industries. However, we are going to start with something simpler; what is the best way to form a queue, that is line up, for something like a drinking fountain. Queuing theory provides a classic example of how equity and efficiency often do not mix. (This example is derived from a puzzle in the Journal of Economic Perspectives, Summer 1989).
Suppose there is a water fountain which can be used by only one person at a time. People arrive randomly (according to some technical conditions that are not important here) so that the waiting time remaining for the last person in line is independent of when the next person arrives in line. Each unit of waiting time is equally costly, no matter who does it. As a thirsty individual arrives, she must decide whether to wait in line or leave. If she leaves, she may not come back. The question from the vantage of efficiency is how long the line should get, so an optimal amount of waiting time is spent by those wishing to use the fountain. If there is no line, the fountain is under utilized. Too long a line means wasted time. Equity, on the other hand, will deal with fairness about who should get first dibs at the water fountain.
In most countries, social convention has arrived at an equitable solution of first-come first-served. While this may be fair, it is not efficient. The problem is that there is a cost that the person joining the line does not feel. Anyone who enters the line increases the waiting time of anyone who joins the line later. A person joining the queue does not account for this additional cost, looking only at his or her personal cost in waiting time. The result is that lines are too long and there is too much waiting.
But economists come to the rescue with a solution that leads to optimal queues. For efficiency, there should be just the right number of people in line. What that means is the social value of waiting in line for the last person (the opportunity for that person to get a drink of water) should be made equal to that persons cost of waiting to get that drink. If somebody finishes drinking before another person enters the line the person who was last, weighing the cost of waiting against the benefit of drinking, now has lower costs. Her benefits exceed her costs. The line is now one person too short.
But suppose the last person in line knew that she would be replaced by the latest arrival if someone arrived before the person drinking was finished. In this case, if anyone arrives, the last person leaves, is replaced by a new last person, and the line remains at optimal length. In fact, it does not have to be that the last person is replaced. If the new arrival is placed anywhere in front of the last person in line, this system gives an efficient line length. First-in first-out is the only inefficient queuing rule.
Among the efficient rules that are viewed as particularly inequitable is the last-in first-out convention. In this case, the last person to arrive is served first. This pushes everyone else in line back one spot, causing the last person, who viewed the benefits just equal to the cost, to leave. And if you think last-in first-out is never used, think again. Telephone calls are often served immediately at stores and ticket agencies, even if there are people waiting in line on site.
The British are known for their queuing behavior, lining up quietly with an air of equity that they claim is efficient. But now you know better. Pushy people, who cut in line well beyond the end, may not be nice, but they are efficient. That summarizes the riddle economists often face in efficiency and equity. People and policy makers often do not like the efficient solution, but decry the costs (in terms of inefficiency) of what is perceived as the equitable one.
Normative and Positive Economics
Out of the queuing example comes one more issue that is the basis for a philosophical discussion in economics about what we should be doing as economists. This is the concern of normative versus positive economics. For short definitions, normative economics can be thought of using economic analysis to determine how things ought to be, evaluating economic policy on the basis of the desirability of alternative outcomes. Positive economics is using economics to determine how things are, seeing or forecasting the changes that result if a policy is implemented. Although not completely separate, the two approaches give different feels to economics.
The queuing example is a nice illustration of the tension between these two points of view. An economist who takes the "positive" view towards his discipline is likely to try to explain why the equitable first-come first-served convention came about. Then he would check different rules of behavior efficiency. The economist might even try to test how some alternative service rules would affect waiting times and individual behavior.
But the normative economist approaches the problem differently. She would first try to find the efficient solution to the queuing issue. Then she would figure a way to change incentives or instill a rule to achieve her solution. If people believe in equity, then the incentive structure would have to include elements of what is perceived as fair. While it is possible that the two types of economists would arrive at the same conclusion, they approach it from very different directions.
Policy makers also have to face these divergent approaches, of normative and positive. They believe in efficiency (a normative concept), so they wish to instill competition in the economy. But they also must deal with facts, that monopolies may arise, and unequal distributions of income (both positive aspects of economic analysis). The choice is always there.