Economic theory: the good and the bad

Markets and Efficiency (this section is just barely started and now paused for the election)

I’m an economist. I design and modify electricity markets, and I believe markets are the best tools for solving many economic problems. But, by themselves, they can’t solve many important economics problems. With some clever external controls, they can solve a wider range of problems. This view is not uncommon, but many fundamental mistakes are made by those who criticize markets as well as by market fundamentalists who believe markets can solve nearly every economic problem and quite a few others. Allow me to explain some well accepted, but often misunderstood economic principles.

What is economic “efficiency,” and why it means less than often supposed.

The central concept of economics is “economic efficiency.” The economic meaning is almost the same as in English, but one key aspect of the economic concept causes misunderstanding between economists and others. Efficiency covers both production and distribution, and the confusion lies on the distribution side.

If eight people divide a pie and each gets a 1/8th slice, the pie is divided efficiently. I am using the word in its economic sense and will continue to. What may surprise some, is that giving one person the whole pie and the others nothing is also economically efficient. This is because it is what economists call a Pareto optimal distribution of the pie. In this case “Pareto optimal” and efficient mean the same thing. A distribution is Pareto optimal, PO, if no one can be made better off without making someone worse off. Once one person has been given the whole pie, no one can be given any without making the first person worse off, hence giving all to one is PO and, technically speaking, efficient.

When Idi Amin owned everything in Uganda, that was economically efficient. Of course egalitarian distributions are also efficient. So what is inefficient. If we divide the pie into nine pieces, give one piece to each of the eight people, and drop the last piece on the floor, that is inefficient. The point is that when an economist say a certain scheme is efficient, that does not mean it’s good. It just means that nothing is utterly wasted, it may still be horribly unfair.