In any society at any point of time all the resources would be relatively scarce. We cannot have whatever we want. We need to decide our priorities and then distribute the resources. In such a situation we need to take into consideration goals of efficiency and equity (sense of fairness). If the distribution of resources or goods in an economy is fair between different members of the society, it indicates equity. Efficiency is making the best out of scarce resources at the best possible price. Efficiency refers to the size of economic resource and equity refers to how this economic resource is distributed. When the resources are distributed we will be faced with a trade-off between efficiency and equity. This trade off is a central principle in economics.
The best example of trade-off between equity and efficiency can be explained with environmental policy of the government. Who gets the most out of exploiting the natural resources and what cost is a policy question that needs to be answered. The projects undertaken would have an adverse effect on the local people who might be living there from many generations. These become the victims of the project. But government programmes and projects would have multiple objectives in the larger interest of the nation. So there would have to be a trade off between the efficient use of resources in that area and the equity of resources distribution to the people of that area. In order to do that the people who are enjoying the benefits of the policy would have to pay for the victims of the policy and make them the stakeholders in the developmental works undertaken.
The hardest problems are those that involve trade-offs, especially between improving the efficiency of the market and promoting equity. Many times government takes hard trade-offs but sometimes efficiency and equity go hand in hand. Providing Educational opportunities and health infrastructure to the poor will be both equitable and efficient at the same time. It provides for fair distribution of the resources for the well being of the people which in turn increases the efficiency of the economy because more number of people will be productive. We can observe these kinds of policies more in developing countries where the state would undertake land reforms, tax concessions, and welfare programmes etc., for the people. Here the government concentrates on the inefficacy of the market and inequalities it produces and tries to counter them through a slew of measures.
Economy alone cannot decide on the best way to balance equity and efficiency. This issue involves the social and political factors also. Let us look at the Tax system in India for our case. India in the early years after independence used to have a progressive system of taxation in which the rich people had to pay higher amount of taxes depending on the their income in that particular year. But the after liberalization our economic and political agenda differed on the views on equity and efficiency. It was argued that high tax rates reduce economic efficiency and also incentive to work. So tax reforms were brought and now there are only three slabs are present for income tax. Even the highest earner would pay not more than 30% of his income as tax. We can see that there is a constant trade off between equity and efficiency in this case.
We can conclude that there is often a trade-off between equity and efficiency but that might not apply to all the cases. Most of the social welfare measures that we undertake can be aimed at both equity and efficiency. In some cases efficiency may be compromised for equity and in other cases equity may be compromised for efficiency. But all these kind of decisions would be taken under a guided and well informed policy making environment so that it works for the overall well-being of the society concerned.