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Friday, December 28, 2012

The Meaning of Efficiency In Economics

I just saw a link to a blog post, and the title of the blog post is "No, Christmas Is Not an 'Economically Efficient' Holiday (and That's Okay)."  The sub-head is "If you were to design, from scratch, a gift-giving holiday to warm the hearts of the coolest classical economists, it would look nothing like December 25. But gift-giving rituals have never been about the economics of efficiency ..."

So I'm an economist, and how do I react to such an argument?  Well, let's start with what the introductory economics textbook I just finished using (I did not choose it, so don't blame me), Macroeconimics, 4th Ed., written by Glenn Hubbard and Anthony O'Brien define economic efficiency (p. G-2):
"Economic efficiency   A market outcome in which the marginal benefit to consumers of the last unit produced is equal to the marginal cost of production and in which the sum of the consumer surplus and producer surplus is at a maximum."
Greg Mankiw, in the glossary of his intro econ text (Principles of Economics, 6th Ed., p. 834) defines efficiency as "the property of society getting the most it can from its resources."  On p. 145, he comes very close to Hubbard & O'Brien's definition:  "the property of a resource allocation of maximizing the total surplus received by members of society." 

I've always had a different take of efficiency.  My take is that an action, or a set of actions, is efficient if it achieves a desired--and desirable--outcome at the lowest possible cost.  (Ken Boulding, somewhere--I think in his remarkable book Economics as a Science--talked about "sub-optimizing," which he defined as "doing very well something you should not be doing at all.")  Note that the outcome, in my version of this, is key.  Unless the outcome is both desired and desirable, achieving it cannot be efficient.  I believe strongly that my interpretation is the correct one, even within economics.

Indeed, both the Hubbard & O'Brien version and the Mankiw version work--if the outcomes from mmarket processes are desired and desirable.  That is, if and only if markets are (1) competitive, (2) free from externalities, and (3) operating under conditions of complete information, markets will generate efficient outcomes.  As near as I can tell, that excludes any actually existing markets.

But my view is not the majority view in the profession, and it's easy to find examples.  Joel Waldfogel's article "The Deadweight Loss of Christmas" is one prominent (and fun) example (and was published in the profession's most prestgious journal, the American Economic Review):
"In the standard microeconomic framework of consumer choice, the best a gift-gver can do with, say, $10, is to duplicate the coice that the recipient would have made.  While it is possible for a giver to choose a gift which the recipient ultimately values above its price--for example, if the recipient is not perfectly informed--it is likely that the gift will leave the recipient worse off than if she had made her own consumption choice with an equal amount of cash.  In short, gift-giving is a potential source of deadweight loss."  (p. 1328)
The solution, of course, is to give cash.   But Waldfogel's analysis overlooks what the desired--and desirable--outcome is.  That outcome is for the giver to express his/her affection for the recipient, to demonstrate "caring" in a way that shows that the giver has thought about what the recipient will value, and for the recipient to receive the gift as an expression of that affection and caring.  The gift is not the thing being given, and to mistake the gift for the embodiment of the gift is a category error.  In fact, this explains why people are often--most often, when there is thought to be a close emotional relationship between giver and recipient--offended by gifts of cash.  A gift of cash is, in my terms, inefficient.

Efficiency in economics, then, is not about maximizing surplus (maximizing surplus is, under certain very restrictive conditions a consequence of efficiency), or about maximizing progits, or about maximizing Gross Domestic Product.  It is about achieving desired and desirable outcomes.


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