G401 September 27, 1998 Professor Rasmusen, Erasmuse@Indiana.edu NOTES ON DISTRIBUTION G401. Pareto optimality and efficiency. Split 100 dollars between Mary and John. A: 50-50. B: 40-40. C: 90-10. Which is efficient? A or C. But if you care about equality, you might like B better than C. Why might you care about equality? Good question, but people do. If you make a change, can you compensate the losers? If you take away a monopoly position, can you make the monopolist better off, as well as consumers and taxpayers? If you remove a tariff, can you make domestic producers better off? If you have 20 cars to give as rewards to 50 employees, all equally capable and hard-working, what do you do? Pick 20 randomly? Pick the 20 most senior? Pick the 20 most junior? Pick the 20 who need the car most for work? Pick the 20 who need the car most for going home? Let them decide? Have them evaluate each other? Sell the 20 cars and split the money among them? Have them organize a lottery? Intellectual property. Patents: inventions, short lifetime. Copyright: Books, songs, films, long lifetime. Trademark: names and symbols, infinite lifetime. Sustainable and Unsustainable Advantage. Coca Cola vs. Disney copyrights about to expire. Some Further notes: (1) Monopoly Diagram. I did one in class, but a simpler one with a flat marginal cost for the firm can make the same point. By losing its monopoly, the firm loses profit area A, but consumers gain benefit A+B. If the government could impose a lump sum tax on consumers of A, it could collect money to compensate the firm for losing the monopoly, resulting in a Pareto improvement. A sales tax wouldn't help, because the tax would have to be so big that the cost to consumers would rise back up to where the monopoly price was. What if the firm is *not* compensated? Is ending the monopoly still a benefit to society? People usually say Yes because the change helps the consumers more than it hurts the firm. This is another definition of an efficient change, sometimes called `Wealth maximization'' or `Surplus maximization` or `Kaldor-Hicks Efficiency`. (2) Further notes on the distribution of wealth. Compare these three situations: (X) Joe get 100 dollars, Anne gets 100 dollars. (Y) Joe gets 100 dollars, Anne gets 200 dollars. (Z) Joe gets 101 dollars, Anne gets 120 dollars. There are three political philosophies that would argue over which is best of these. EGALITARIAN: Someone who thinks equality is all-important would prefer X, because Joe and Anne are equal. UTILITARIAN/EFFICIENCY: Someone who likes to maximize wealth would prefer Y, because total wealth is greatest. RAWLSIAN LIBERAL: The Harvard philosopher John Rawls proposed that Z is best. His criterion is: Maximize the wealth of the worst-off person in society. This example makes the utilitarian look best, perhaps. But suppose we add (W) Joe gets 1 dollars, Anne gets 1000 dollars. The utilitarian would like this best of all. Other political philosophies would say the whole question is wrongly set up. The way it is set up here, we don't ask why X, Y, Z, and W differ. Some people say that is the main thing: if W results from Anne working hard and Joe slacking off, that's fine. If it results from Anne stealing from Joe, then it's not fine. These same issues come up in the workplace with employee compensation, as we discussed in class with the 20-cars-for-50-people example. They are basic to everything that the government does, because government actions always have some impact on efficiency and also some impact on the distribution of wealth. We'll see that again and again in G401.