Economic efficiency has some potential flaws, flaws I will certainly discuss but unfortunately most of the critiques of efficiency are not grounded on any real understanding. I still remember reading an article against “economic efficiency” that argued we should focus on higher quality rather than more which is… Anyway without further ado a crash course in what economic efficiency really is.
The essential idea of economic efficiency is that a more efficient state is a world with more, but this concept might be harder to fully understand than it first appears. Ten apples might be more than five apples, but which is more: a chair, or five chickens? Three ergonomic office chairs or one extravagant throne? In prior examples, we talked about how trade creates wealth even when we are just moving one object around with nothing being produced, but how can the same amount of stuff possibly be more? This concept is essential to an understanding of economic efficiency and its importance.
We tend to talk in terms of money: consumer surplus is willingness to pay in contrast to that which is actually paid, producer surplus is what the producer would accept for their sacrifices in contrast to what is actually paid to them. This though, can lead to several misleading thoughts such as a misunderstanding surrounding the importance of money. If a women who graduated from the top of her class at *insert high status university here* got a job offer to work in Wall Street for $200,000 dollars a year, but instead she decides to instead become a hermit meditating in the woods, the world in which she is a hermit is a world with “more”. Yes such wealth will not show up in any sort of economic measurement, but that reflects an impoverishment in our ability to measure, not a repudiation of the concept. Measurements, after all, are forced to focus on only that which may be easily observed and reliably quantified.
Remember money itself is just a means that allows for an easier exchange of resources. We measure everything in terms of money, not because of money’s importance, but instead because of the real goods and services that the money represents. Remember we actually assume that money itself has no value; a giant pile of money that cannot be traded for real goods would be worthless. In the case of the woman, we can imagine what real goods she would purchase with that 200k as well as any discomfort from the work that would be required of her to do in order to earn it. She has the option between that real basket of goods and living a quiet life in the woods. It is impossible for us as outside observers to know which is set of goods is more. Her choice is the only way we can determine which set of real goods is more valuable to her and thus can be considered to be “more”. Though it is true that as a hermit she is exceedingly unlikely to create benefit for others, it is also true that her being unwilling to work in finance reflects that those who would benefit from her labors are themselves not willing to sacrifice enough of their own resources to compensate her for the difference between the two lives.
So let us try to run through an efficiency example using this idea and only real goods to hopefully get a clearer understanding of what “more” means and how trade can create more even when it is merely shuffling goods. Let’s say that we have a vastly oversimplified two-good economy with rice and meat, with two people about to make a trade. There is Jesse who wants to have more rice and is willing to trade some meat for it, and there is Stella who (conveniently enough for this example) wants to have more meat and is willing to trade some of her rice for it. For Jesse, he would value 5 kg of rice equally to 1kg of meat. That is, if offered those two sets of real goods he would be indifferent, if offered a little more rice or a little less meat he would certainly choose the rice and vice versa. Stella’s tastes are a little more carnivorous, she values 1kg of meat at a whopping 20kg of rice. As we should know from chapter three, the different set of preferences means they could potentially trade with 1kg of meat being valued anywhere between 5 and 20kg. Let’s say the bargain is struck where Stella will provide 10kg of rice to Jesse in exchange for 1kg of meat[1]. What is the surplus in this case, and why?
Stella would have been willing to give an extra 10kg of rice to Jesse. So now, she has something she values at 20kg of rice, but she only had to trade away 10kg. She therefore went from having 20kg of rice value to having 30kg of rice value (or 1.5 kg of meat value if you prefer), so her surplus is then equal to 10kg of rice (.5kg meat). For Jesse, he gets the rice he so coveted, sacrificing only half the meat he would have been willing to give up, so his surplus is 5kg of rice (or 1kg meat). We can then say that total surplus from this trade is equal to 15kg of rice or equivalently 1.5kg meat. To really understand why this is, imagine that instead the two could not trade, and that you were responsible for making sure that they had a collection of real goods that they would value the same amount as the one trade gave them. You would have to either create 15kg of rice, giving Jesse 5kg and Stella 10kg, or you would have to create 1.5kg of meat and give .5kg to Stella and 1 kg to Jesse. In either case, you would need to make more by the amount of surplus we calculated, in order to come up with a scenario that is equally satisfying to both parties as that which was arrived about merely by moving meat and rice between the two. So even though trade in this case does not alter the amount of rice in the economy, for this reason we can say the economy grew in wealth by the equivalence of 15kg of rice or 1.5kg of meat. It is in this way that we can say there is “more”.
Money makes all this easier because each person can only value a dollar as a dollar. Essentially anytime we transact for money, we are actually exchanging real goods for real goods with the world becoming wealthier each time by the difference between the sacrifice you would have been willing to make and the one you actually made. The benefit of money is that we don’t actually need to receive our goods from the person that we gave our resources to. Thus I can give economics lessons to students intent on learning it, and get my meat from ranchers, rather than scouring the world looking for a rancher desperate to turn meat into knowledge of demand curves and economic efficiency. It is really not very intuitive at all, but always try to look past money into the flow of real goods.
[1] The actual price is unimportant so long as it falls within the range of trade, as it just changes who gets what surplus but not the amount of surplus to be gained, if meat traded for an extra bag of rice it would just mean Jesse gets 1 more bag worth of surplus, and Stella one less.
Homo Economicish 