Unit 5 The rules of the game: Who gets what and why

5.10 Lessons on the impact of institutions on efficiency and fairness

The outcomes of the different cases we have considered are summarized in Figure 5.22.

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https://www.core-econ.org/microeconomics/05-the-rules-of-the-game-10-impact-efficiency-fairness.html#figure-5-22

Figure 5.22 Comparing the cases: the amount of grain produced, Angela’s free time, and how the grain is divided between the two players.

In the first, second, and fourth columns, 46 bushels of grain are produced. This is the quantity produced when the allocation is Pareto efficient; given the available technology and Angela’s preferences, this is what happens when Angela has 16 hours of free time. In contract N, when the legislation has been introduced but before Bruno and Angela negotiate with each other, only 35 bushels of grain are produced.

Figure 5.22 also shows that Angela’s share of the output is higher when her reservation option is better. It ranges from 15 out of 46 bushels (33%) under forced labour, to 32 out of 46 bushels (70%) when the legislation provides a strong reservation option and the two parties negotiate with each other.

The story of Angela and Bruno provides three lessons about efficiency and fairness:

• When one person or group has power to dictate the allocation, subject only to not making the other party worse off than in their reservation option, the powerful party will capture the entire surplus. If they have done this, then there cannot be any way to make either of them better off without making the other worse off (point L in the figure). So this must be Pareto efficient! But it is unlikely to be considered fair.
• If those who consider their treatment unfair have the power to influence the outcome through legislation and other political means, the result may be a fairer distribution in their eyes or ours, but may not be Pareto efficient (contract N). Societies can face trade-offs between Pareto efficient but unfair outcomes, and fair but Pareto-inefficient outcomes.
• If we have institutions under which people can jointly deliberate, agree on, and enforce alternative allocations, then it may be possible to avoid the trade-off and achieve both Pareto efficiency and fairness—as Angela and Bruno did through a combination of legislation and bargaining between themselves (points between P and R).