welfare economics

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Welfare Economics

The study of how to distribute income in order to achieve social good. In other words, welfare economics takes the preferences of individuals at the microeconomic level and tries to apply them in macroeconomics. It attempts to discourage inequality to improve utility. Welfare economics is rather controversial, in part because there is no one way to measure social good; therefore, its study can be subjective.

welfare economics

A normative branch of economics that is concerned with the way economic activity ought to be arranged so as to maximize economic welfare. Welfare economics employs value judgements about what ought to be produced, how production should be organized, the way income and wealth ought to be distributed, both now and in the future. Unfortunately, each individual in a community has a unique set of value judgements, which are dependent upon his or her attitudes, religion, philosophy and politics, and the economist has difficulty in aggregating these value judgements in advising policy makers about decisions that affect the allocation of resources (which involves making interpersonal comparisons of UTILITY).

Economists have tried for many years to develop criteria for judging economic efficiency to use as a guide in evaluating actual resource deployments. The classical economists treated utility (see CLASSICAL ECONOMICS) as if it was a measurable scale of consumer satisfaction, and the early welfare economists, such as PIGOU, continued in this vein, so that they were able to talk in terms of changes in the pattern of economic activity either increasing or decreasing economic welfare. However, once economists rejected the idea that utility was measurable, then they had to accept that economic welfare is immeasurable and that any statement about welfare is a value judgement influenced by the preferences and priorities of those making the judgement. This led to a search for welfare criteria, which avoided making interpersonal comparisons of utility by introducing explicit value judgements as to whether or not welfare has increased.

The simplest criterion was developed by Vilfredo PARETO, who argued that any reallocation of resources involving a change in goods produced and/or their distribution amongst consumers could be considered an improvement if it made some people better off (in their own estimation) without making anyone else worse off. This analysis led to the development of the conditions for PARETO OPTIMALITY, which would maximize the economic welfare of the community, for a given distribution of income. The Pareto criterion avoids making interpersonal comparisons by dealing only with uncontroversial cases where no one is harmed. However, this makes the criterion inapplicable to the majority of policy proposals that benefit some and harm others, without compensation.

Nicholas Kaldor and John Hicks suggested an alternative criterion (the compensation principle), proposing that any economic change or reorganization should be considered beneficial if, after the change, gainers could hypothetically compensate the losers and still be better off. In effect, this criterion subdivides the effects of any change into two parts:

  1. efficiency gains/losses;
  2. income-distribution consequences.

As long as the gainers evaluate their gains at a higher figure than the value that losers set upon their losses, then this efficiency gain justifies the change, even though (in the absence of actual compensation payments) income redistribution has occurred. Where the gainers from a change fully compensate the losers and still show a net gain, this would rate as an improvement under the Pareto criterion. Where compensation is not paid, then a SECOND-BEST situation may be created where the economy departs from the optimum pattern of RESOURCE ALLOCATION, leaving the government to decide whether it wishes to intervene to tax gainers and compensate losers.

In addition to developing welfare criteria, economists such as Paul Samuelson have attempted to construct a social-welfare function that can offer guidance as to whether one economic configuration is better or worse than another. The social-welfare function can be regarded as a function of the welfare of each consumer. However, in order to construct a social-welfare function, it is necessary to take the preferences of each consumer and aggregate them into a community preference ordering, and some economists, such as Kenneth Arrow, have questioned whether consistent and noncontradictory community orderings are possible.

Despite its methodological intricacies, welfare economics is increasingly needed to judge economic changes, in particular rising problems of environmental POLLUTION that adversely affect some people while benefiting others. Widespread adoption of the ‘polluter pays’ principle reflects a willingness of governments to make interpersonal comparisons of utility and to intervene in markets to force polluters to bear the costs of any pollution that they cause. See also MARKET FAILURE, NORMATIVE ECONOMICS, RESOURCE ALLOCATION, UTILITY FUNCTION, CARDINAL UTILITY, ORDINAL UTILITY.

References in periodicals archive ?
In my opinion, the reaching of this opinion involved a change of mind comparable to Stigler's, this completely deflates the concept of the externality, giving real strength to Coase's claim that its having 'come to play a central role in welfare economics [has had] results which have been wholly unfortunate'.
2009, Behavioral Welfare Economics, Journal of the European Economic Association, 7: 267-319.
Ses preoccupations au sujet de iequilibre concurren tiel et l'optimalite dans un contexte d'incertitude, lui ont amene a pub Her en 1963 un article intitule "Uncertainty and the welfare economics of medical care ", lequel est reconnu comme la genese de l'economie de la sante.
Toward a Reconstruction of Utility and Welfare Economics.
When viewed from the mainline of economic discourse, second-best theorizing, along with its welfare economics parent, is an exercise in trying to fill what are imaginary analytical boxes that cannot be filled in any substantive manner.
Sen's idea of welfare economics is closely linked to his view of tolerance.
Welfare economics starts with the premise that economic welfare is the measure of people's economic well-being.
The new welfare economics 1939-1974, International Economic Review 19(3): 547-584.
This approach is grounded in the principles of neoclassical welfare economics, in which improvements are assessed according to the Pareto principle and compensation criteria (4).
Dwight Jaffee, University of California at Berkeley, and Thomas Russell, Santa Clara University, "The Welfare Economics of Catastrophic Loss"
His areas of interest include: Food and Consumer Welfare Economics, Development Economics and Agricultural Innovation.
Pigou's insight has not been expressed in the fundamental assumptions of microeconomics, nor has it been incorporated into welfare economics, nor discussed in the conclusions of general or partial analyses based upon them.