Efficiency and equity: A general equilibrium analysis of rent‐seeking

Abstract

AbstractWe study the rent‐seeking phenomenon using a simple, static general equilibrium model. The economy consists of two sectors, both employing a constant returns‐to‐scale technology with labor as its sole input. One of the sectors is a monopoly, where a continuum of agents compete for a share of monopoly profits (i.e. rent). Agents are heterogeneous in labor productivity and rent‐seeking ability: they face a choice between engaging in (productive) work or vying for a share of the rent (i.e., a contest against other rent‐seekers). At the aggregate level, rent‐seeking reduces the available amount of labor in the economy and thereby lowers output and welfare (rent‐seeking is inefficient). At the individual level, rent‐seeking shifts income towards rent‐seekers. Consequently, an economy with few rent‐seekers tends to have high income inequality: an effect that is exacerbated by the fact that rent is decreasing in the number of rent‐seekers (low levels of rent‐seeking increase inequity). This tradeoff between efficiency and equity is the primary focus of this paper. We investigate how the distribution of rent‐seeking ability and the correlation between labor productivity and rent‐seeking ability shape this tradeoff.