Thursday, April 12, 2012

Pareto Efficiency

According to definition, a Pareto efficient situation is one at which no party can be better off without making another party worse off. To be more specific, all resources are being used. Similarly, a Pareto inefficient situation is one at which one or more parties can gain something without making anybody else worse off.
These definitions are a little vague, so I will illustration a simple example. Let’s pretend that you and I are walking and we come across a gold mine with five nuggets, and we each take two. This is a Pareto INefficient situation because there is one nugget remaining and either one of us could take it without making the other worse off. Although we were trying to be fair be each only taking two, we are also being inefficient according to the aforementioned theory. Let’s now say that you decide to take the one remaining gold nugget. We are now in a Pareto efficient situation, because all resources are distributed. In addition, neither party can have an additional nugget without steeling from somebody else.

Notice, however, that Pareto efficiency has nothing to do with equality. All resources in the world have to be in use—however, they can be used by one person or by seven billion people.
If, for example, you went ahead of me and got all five nuggets, the situation would still be Pareto efficient. Although I would have zero, it would not matter according to the theory. As you can see in the graph below, there are many Pareto efficient points. They all equality ‘efficient,’ so any one of these points would satisfy efficiency in the same way.

Game Theory: Prisoner’s Dilemma

Prisoner’s Dilemma, a famous game used to demonstrate the ironic nature of incentives, is one example of game strategy. In the game, there are two arrested prisoners convicted of a crime. The two prisoners are separated into different rooms, where they are asked whether or not they committed a crime (let’s call the prisoners Red and Blue). As seen above , there are four possible scenarios. If Red confesses but Blue does not, Red gets 0 years in jail while Blue gets 3 (visa versa). If they both withhold, they each get 1 year. Finally, if they both confess, they each get 2 years in jail. No matter what circumstance a person considers, they realize that it is always the best choice for an individual to confess.
Now, let’s pretend you are the prisoner named Red. There are two possible scenarios.
I. You think Blue will NOT confess.
[Your Choices: Confess and get 0 years in jail. Don't confess and get 1 year in jail]
If he doesn't confess, then it is in your best interest to confess!

I. You think Blue will confess.
[Your Choices: Confess and get 2 years in jail. Don't confess and get 3 year in jail]
If he does confess, then it is still in your best interest to confess!

Both parties are selfish. It makes sense that even though the best option for both parties not to confess, this would rarely happen. See next two slides for ideal outcome vs actual outcome.

Wednesday, April 11, 2012

Andrew Carnegie: The Gospel of Wealth

In his document titled “The Gospel of Wealth,” Andrew Carnegie makes the excellent point that money should be a symbol of one one’s ambition and hard-work. He proposes that families should not hoard their wealth or pass on their savings to the next generation. He communicates two reasons for this; the first of which is that “it is not well for the children that they should be so burdened.” Carnegie states that by giving a child inheritance, you are taking away their ambition and sense of motivation. Second, Carnegie states that society will have no reason to work if many people gain wealth through inheritance. He states that if too many families hoard their wealth, the country will be in danger of becoming an aristocracy and commoners would no longer have the opportunity to rise to success. Both these points are absolutely true. Carnegie is stating that those who work hard should be rewarded, and that the wealthy should demonstrate “competency, which […] should be the aim of all to acquire.” I also respect the fact that Carnegie believes that the rich should help the poor and that this help should come in the form of resources such as libraries and educational institutions—not cash. Carnegie clearly adhered through the philosophies he preached. He funded many charities in his lifetime and created an extremely respectable University (Carnegie-Mellon). He communicates the rich man’s burden as providing “moderately for the legitimate wants of those who depend upon him.” He states that the rich should help the poor get to their level, however this transition must come only after struggle. In the document, he also states that 'death taxes' can be necessary in cases where a person does not voluntarily give up their fortune.
However, there can be an argument on the other side as well. Parents want to provide security to their kids, so is it really fair that we should take this right away? Perhaps some people work to provide for their family and for the generations that will follow them.
"The Gospel of Wealth" is controversial, but it is absolutely worth reading through. Carnegie definitely offers some "food for the thought." I, myself, was conflicted while reading the document. While his ideas sound great in theory, I feel they might not be practical. I will attach a link to the document below. Feel free to offer your insights and let me know what you think in the comments!