Income Equality and Efficiency: Study with Video Lessons, Practice Problems & Examples

The relationship between income equality and efficiency highlights a trade-off: while perfect equality maximizes total utility, it can reduce incentives for hard work, leading to inefficiency. Diminishing marginal utility illustrates that as income increases, the additional satisfaction from each dollar decreases. For example, redistributing income from a higher earner to a lower earner can increase overall utility. However, perfect equality may discourage productivity, emphasizing the opportunity cost of equality versus efficiency in economic systems.

Income Equality and Efficiency

All right. So now let's see the relationship between equality and efficiency. So let's talk about income inequality versus income efficiency, all right? In the case of perfect equality, right, if everything was perfectly equal, we're going to maximize what we call the total utility of the population. Okay? So this utility of course in economics and math, we always want to quantify everything. So utility is going to be a quantitative measure of happiness or satisfaction. Okay, so obviously this is a kind of a really abstract topic, but it helps us make some conclusions. This is kind of the idea of saying something like oh man I'm gonna eat this slice of pizza, it's giving me 100 units of utility right now, right? It's really weird to think about, but it helps us to make our calculations. Alright, so it's really abstract, you can't really say how many units of utility you get from something, but we can make some conclusions about utility itself. Alright? So we're going to talk about marginal utility and and marginal utility is going to be marginal, right? One more. When we talk about marginal, we're talking about 1 more. So what's the additional utility, the additional satisfaction from consuming one more unit, right? Or in this case, spending 1 more dollar, right? Because we're talking about income equality here. So if we're going to spend one more dollar, how much extra happiness are we gonna get? And as we've seen with many other topics, we're going to have the diminishing returns come back into play here, right. As we spend more and more dollars, we're going to get less utility from each dollar we spend. Let's think about back to pizza, that first slice of pizza you eat, it's gonna bring you a lot of utility because you're hungry, because you love pizza, the 2nd slice it's still good, but think about that first bite of pizza, how much better it was than when you're just eating more pizza. 3rd slice, 4th slice, you're getting less and less satisfaction as you eat more and more of it, right? So that's going to have that diminishing returns that we're talking about. So let's think about this example economy where we've got just 2 people, let's keep it simple. We've got Aaron and Blake. I got these names from this hilarious Key and Peele sketch I was I had just watched like 5 minutes before and it's the substitute teacher sketch on Key and Peele, type it into YouTube, it was really funny. So we've got Aaron earning $2,500 and Blake earnings excuse me, Blake earning $7,500 right? So there is an equal income here. Aaron's only earning $2,500, Blake's earning $7,500. So what's gonna happen if the government say collects all the revenue, they take the money from Aaron, they take the money from Blake and they spread it evenly? Everyone gets the same amount. Well, let's see how this affects their utility. Alright, so here we've got 2 graphs, 1 for Aaron, 1 for Blake and let's see where we started. Aaron was originally earning $25,000 right, and notice that these curves, we've got a marginal utility curve that's downward sloping, right, it has this downward slope because of the diminishing returns, right? Every extra dollar you spend, you're gonna get less satisfaction. Think about superstars, right? If they've got 12 cars in their garage, think about what it's gonna how much happiness they get from buying a 13th car. Probably not as much happiness as someone buying their first car, right? There's gonna be this difference. So let's extend that here. Aaron's got $2,500 where Blake's got $7,500. Notice right here already, the marginal utility that Aaron would get from 1 more dollar is much more than the marginal utility that Blake would get from 1 more dollar, right because he's already much further down in his diminishing returns. So if the government were to collect all the revenue and distribute it evenly, well let's see what would happen. There's $10,000 in total revenue, right? There was $2,500, $7,500 that gives us $10,000 total, so if they split it evenly everyone would get $5,000. So first let's talk about Aaron over here, he would move from here to here, right? So he would be getting all that extra utility from spending each dollar and this right here that I'm shading, we could say this is the extra utility he's getting, all right? The extra utility gained utility I'm gonna put here, from getting that extra money, right? The government collected and he earned he got extra money that originally was Blake's and Blake was over here at $7,500 and he's gonna go down to $5,000 so he's losing some money, right? And I'll do this one in red. So we got this and this. Red seems like a lost kind of color. So there we go. This is the lost utility. Right? Lost utility. But notice that the utility that Blakе lost is less than the gained utility by A. A. Ron, right? And this has to do with where they were on their marginal utility curve, right? So in total, if we think about the total utility in the nation, well now there's more total utility right because the gain from Aaron is more than the loss from Blake there. Alright, so there is the positive side of this income equality where we have the maximum amount of utility in theory going on there right, but what happens if we have this case of perfect equality, we're gonna have the lack of incentive. We've talked about this before and we're going to see this again. In perfect equality, the population lacks the incentive to work hard. If I'm going to make the same amount of income, whether I work really hard or if I don't work and the government's just gonna collect everything and just hand me my paycheck regardless of what I do, why should I work hard? I could just go to the beach all day and I'm gonna make the same amount of money as if I had gone to work every day and struggled really hard, right? So this perfect equality, it gives up efficiency, right? Greater equality comes at the price of reduced efficiency, right, and we say that this is the opportunity cost. The opportunity cost of equality is efficiency and this is what we call the quality efficiency trade-off. Alright, that's about it here. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the relationship between income equality and efficiency?

The relationship between income equality and efficiency involves a trade-off. Perfect income equality maximizes total utility, as redistributing income from higher earners to lower earners increases overall satisfaction due to diminishing marginal utility. However, this can reduce incentives for hard work and productivity, leading to inefficiency. In essence, greater equality can come at the cost of reduced efficiency, as individuals may lack motivation to work harder if their income remains the same regardless of effort. This trade-off is known as the equality-efficiency trade-off.

How does diminishing marginal utility relate to income redistribution?

Diminishing marginal utility means that as a person’s income increases, the additional satisfaction (utility) gained from each extra dollar decreases. In the context of income redistribution, transferring money from a higher earner to a lower earner can increase overall utility. The lower earner, who is at a higher marginal utility, gains more satisfaction from the additional income than the higher earner loses. This concept supports the idea that redistributing income can enhance total utility in an economy.

What is the equality-efficiency trade-off in economics?

The equality-efficiency trade-off in economics refers to the balance between achieving income equality and maintaining economic efficiency. While perfect equality can maximize total utility by redistributing income to those with higher marginal utility, it can also reduce incentives for hard work and productivity. This lack of motivation can lead to inefficiency, as individuals may not strive to be more productive if their income is guaranteed regardless of effort. Thus, the opportunity cost of achieving greater equality is often reduced efficiency.

Why does perfect income equality potentially reduce incentives to work hard?

Perfect income equality can reduce incentives to work hard because individuals receive the same income regardless of their effort or productivity. If the government redistributes income to ensure everyone earns the same amount, people may feel less motivated to work harder or be more productive, knowing that their additional effort will not result in higher earnings. This lack of incentive can lead to inefficiency, as the overall productivity of the economy may decline when individuals do not have a financial motivation to excel in their work.

How does the concept of marginal utility explain the benefits of income redistribution?

The concept of marginal utility explains that the additional satisfaction (utility) gained from each extra dollar decreases as a person’s income increases. In income redistribution, transferring money from a higher earner to a lower earner can increase overall utility because the lower earner, who is at a higher marginal utility, gains more satisfaction from the additional income than the higher earner loses. This means that redistributing income can enhance total utility in an economy, as the gains in utility for lower earners outweigh the losses for higher earners.