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 ?
(2016), 'Beyond welfare economics: Some methodological issues', Journal of Economic Methodology, 23 (2), 185-202.
Similarly, the proponents of a more deontological approach do not necessarily dismiss the consequentialist approach of welfare economics. For instance, Wils, who is critical of proponents of the 'so-called more economic approach' still argues that in competition law '[b]oth intellectually and institutionally, economic and legal analysis should be integrated'.
Although Atkinson's account of the importance of welfare economics in the post-war curriculum of the 1950s and 1960s is perhaps exaggerated, he was nonetheless correct to notice just how little welfare economics is included in the economics degrees of the twenty-first century.
It is not only Kenneth Arrow who, as Levy and Peart write, "called into question the soundness of the new welfare enterprise." With Samuelson, welfare economics itself finally proved what it had set out to disprove--that is, the methodological capacity of economic experts to dictate public policy.
There is a large, general literature on behavioral welfare economics, including Bernheim (2009), Bernheim and Rangel (2009), Manzini and Mariotti (2012, 2014), Rubinstein and Salant (2012), Salant and Rubinstein (2008), and Sugden (2004).
His concerns about competitive equilibrium and optimality under uncertainty conditions led him to publish what would be recognised as the seminal article on Health Economics, "Uncertainty and the welfare economics of medical care".
The same is true for Rothbard's approach to welfare economics, which also comes under fire.
As welfare economics developed, it acquired the same formalistic character as the rest of economic theory came to acquire.
in the affirmative by applying the four environmental analytical frameworks of welfare economics, the commons, ecology and public choice theory to intellectual property rights (IPRs).
The era of mindless welfare economics is over as it caused strain on the financial health of the country.
However, Sen's preference to 'formally' work on welfare economics and human deprivation has been misrepresented - by Bhagwati - to be anti-growth.
However, the link between profit and prosperity is not often clear, partly because the development of theoretical welfare economics has obscured the factors that lead to prosperity, which in turn has painted a misleading picture of the role of profit in a market economy.