Cambridge International as and a level Economics Ebook

Equity: 
where the distribution of, say, income or wealth is fair.
KEY TERM
Equity has two sides to it. Th
ese are:
1 
horizontal equity, whereby consumers and others with 
the same circumstances should pay the same level of 
taxation
2 
vertical equity, whereby taxes should be fairly apportioned 
between the rich and the poor in society.
Th
e various types of market failure discussed in
 Chapters 3 
and 6 have resulted in effi
ciency and equity being major 
objectives of microeconomic policy. But herein lies a 
problem – policies that are used to promote effi
ciency may 
have the eff ect of increasing inequality. For example, when 
a consumer good is scarce, its price rises; those most able 
to pay will continue to consume but the increased price 
will hurt those on lower incomes much more. Also, those 
who work hard and take risks are likely to be better off than 
others. As a consequence, governments invariably fi nd it 
necessary to have a trade-off between equity and effi
ciency. 
Creating a more equal distribution on income may 
require incentives to be made to improve effi
ciency. Th
ese 
incentives are designed to prompt people to take risks and 
so improve the standard of living for all concerned.
TOP TIP
Equity is not the same as equality. Governments seek to 
reduce inequality in the distribution of income in various 
ways but have had only limited success. At the same time 
they have to ensure that the distribution is equitable 
through its policies being fair to all of the population.
Income and wealth
It is important to distinguish between income and 
wealth
. 
Income, as we saw in 
Chapter 1
, is the reward for the 
services of a factor of production. For labour, it is paid in 
wages and salaries or rent, interest and profi ts in the cases 
Average costs and hence consumer prices will be higher 
than if the company was in private ownership. Th
is situation 
relates to the property rights issue referred to earlier whereby 
there is little or no pressure on managers to be more effi
cient. 
Consequently, productive effi
ciency declines. A further 
related argument is that in a private business, managers have 
the freedom to manage; they can raise funds for investment 
and are not restricted by how the government says that they 
should manage. Effi
ciency, therefore, is a key issue.
Th
ere are, however, valid arguments for the 
nationalisation of certain activities, again from an 
effi
ciency standpoint. One of the best reasons is the natural 
monopoly argument put forward in
 Chapter 7, 
where it 
was suggested that it does not make sense for there to be 
more than one provider of, say, a railway line or a canal. 
With privatisation and competition it can be argued that 
duplication will ensue, leading to ineffi
ciency, higher prices 
and less output. A second reason is that privatisation can 
oft en lead to a private monopoly replacing a state-owned 
monopoly. Th
is will produce few, if any, benefi ts for 
consumers – the monopolist will be able to exert power in 
the market to raise prices and restrict output.
Another argument is that, following privatisation, it is 
invariably necessary for some degree of regulation and control 
to be put in place to protect consumers from the market 
power of large private companies. Without such controls in 
place, prices would rise faster than under state ownership and 
the consumer would lose out. Th
ese are all valid reasons for 
retaining state ownership of an industry. Whether an industry 
is privatised or remains in state control is oft en a political 
decision and not one solely based on economics.