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WELFARE, ECONOMICS
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Meaning and definition, ◦ Welfare economics is concerned with the evaluation of alternative economic situations (states,, configurations) from the point of view of the society’s well being., ◦ Suppose the total welfare in a country is W, but given the factor endowments and the state of, technology, the welfare could be larger for eg: W* . The task of the welfare economics are a), to show that in the present state W < W* and b) to suggest ways of raising W to W*, ◦ Various criteria are used to evaluate these alternative economic situations, among which, Pareto Optimality criterion is one., ◦ Oscar Lange, “welfare economics establishes norms of behavior which satisfy the requirements, of social rationality of economic activity.”, ◦ The term “Social rationality” of economic activity is to be interpreted as that activity which, ensures optimum allocation of resources and therefore guarantees maximum social welfare. In, this context Oscar Lange says, “The norms of behavior established by welfare economics are, supposed to guarantee the optimal allocation of economic resources of the society.”, ◦ Welfare economics studies the conditions under which the solution to a general equilibrium, model can be said to be optimal.
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Value judgements in WE, ◦ A value judgement is a judgement of the rightness or wrongness of something or someone or, of the usefulness of something or someone based on a comparison or other relatively. It is a, judgement based on particular set of value or on a particular value system. – the conceptions, or ethical beliefs of the people about what is good or bad, , ◦ The measurement of social welfare requires some ethical standard and interpersonal, comparisons which involve subjective value judegments. Objective comparisons and, judgements of the deservingness or worthiness of different individuals are virtually not possible, ◦ For example, imposing a tax of Rs. 1000 on individual A and giving it as a subsidy to individual, B will certainly make B better off and A worse off. But who is to say that the society composed, of both individuals is better or worse off as a whole? Determining this involves comparing the, utility gained by individual B (i.e, making interpersonal comparison of utility)., ◦ And even if A has a high income and B has a low income to begin with, different people will, have different opinions on whether this increases social welfare, reduces it or leaves it, unchanged. Therefore, no entirely objective or scientific rule can be defined., ◦ Controversy among economists
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◦ The value of judgements are unavoidable in welfare economics as ‘welfare’ itself is an, ethical term. Any theorems pertaining to choices among various situations to maximize, welfare are also ethical and must rest on some obvious or hidden value judgements.
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Bergson Criterion : Social Welfare, Function, ◦ Used Social welfare function (SWF) as, of the criterion to measure social, welfare, ◦ SWF provides ranking of alternative, states in which different individual, enjoy different utility levels, , ◦ In a economy of two individuals SWF, can be presented by a set of social, indifference curves, ◦ Each curve is a locus of combinations, of utilities A and B which yield the, same level of social welfare, ◦
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◦ Limitations:, ◦ There is no easy method of constructing, ◦ Somebody in the economy must undertake the task of comparing the various, individuals or groups and rank them according to what he/ she thinks their worthiness is, ◦ A democratically elected government could be assumed to make such value, judgements which would be acceptable by the society as a whole
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PERFECT, COMPETITION(EFFICIENCY),, PARETO OPTIMALITY (EQUITY) AND, MARKET FAILURES
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◦ First theorem of welfare economics : an equilibrium produced by competitive markets, exhausts all possible gains from the exchange , or that equilibrium in competitive, markets is optimal., , ◦ Second theorem of welfare economics : when indifference curves are convex to their, origin , every efficient allocation (every point on the contract curve for exchange) is a, competitive equilibrium for some initial allocation of goods or distribution of inputs, (income), ◦ For economic efficiency to be reached. There should be no market failure, ◦ Market failure is an economic situation defined by inefficient distribution of goods and, services in free market. Under this situation individual incentives for rational behavior, do not lead to rational outcomes, ◦ Market failures arise in the presence of imperfect competition, externalities and public, goods .
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EXTERNALITIES AND MARKET FAILURES, ◦ Unintended product or byproduct produced in an economic, activity, ◦ are called externalities because they are felt by the economic, units not directly involved with the economic units that generate, them., ◦ Are called external cost or negative externalities when harmful &, external benefits or positive externalities when they are, beneficial
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◦ 5 types of, , EXTERNALITIES, , External diseconomies of, production, , External diseconomies of, consumption, , External economies of, consumption, , Technical externalities, , External economies of, production
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Externalities and market failures, ◦ When externalities are present, Pareto optimum is not achieved, even in a perfect competition, ◦ Perfect competition leading to efficiency and Pareto optimality, will hold true only when private costs equal social costs and, private benefits equal social benefits
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•Assume : commodity X, produced in a competitive, industry, •D = market demand curve, •Equilibrium price = 12 ,, equilibrium quantity = 6, •S = Σ MPC (Marginal Private, Cost, • S’ = MSC (industry supply, curve including both private, and external cost), • AE = MEC (marginal external, cost), • MSC = MPC + MEC, • efficiency or pareto, optimality requires =, equilibrium price = 14 &, equilibrium quantity = 4
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◦ Pareto optimality are not achieved whenever private and social costs or benefits differ, , ◦ Here MC pricing is neither possible nor viable and pareto optimum cannot be reached
