Welfare Economics and Role of Value Judgements

What Welfare Economics is About

• Positive economics explains “how it is,” focusing on the determination of product and factor prices and how these prices allocate resources in a free private enterprise economy.

• Welfare economics goes beyond explanation and examines whether a particular allocation of resources is efficient, where efficiency means that resource allocation maximises social welfare.

• Welfare economics seeks to establish criteria or norms for evaluating alternative economic states and policies from the perspective of efficiency and social welfare; these norms provide the basis for recommending policies that increase social welfare and ensure the optimal allocation of society’s resources.

• According to William Baumol, welfare economics is mainly concerned with policy issues arising from:

  • The allocation of resources.

  • The distribution of inputs among commodities.

  • The distribution of commodities among consumers.

  • Resource allocation is considered efficient or optimal when social welfare is maximised.

• Because different sectors of the economy are interrelated, a change in one part of the economy affects resource allocation in other parts; therefore, a central issue in welfare economics is determining whether a particular change in allocation will increase or decrease social welfare.

• A major difficulty in welfare economics is that social welfare cannot be measured objectively, because it requires interpersonal comparisons of utility among individuals in society.

• Since the scientific validity of interpersonal utility comparisons was challenged, notably by Lionel Robbins, economists largely adopted the Pareto criterion to evaluate changes in welfare without making such comparisons.

• According to the Pareto criterion:

  • Any change that makes at least one person better off without making anyone else worse off increases social welfare.

  • A change that makes everyone better off undoubtedly increases social welfare.

  • Social welfare decreases when a change makes no one better off and at least one person worse off.

• A situation is Pareto-optimal or economically efficient when resources are allocated in such a way that no rearrangement can make any individual better off without making someone else worse off.

• The concept of Pareto optimality forms the foundation of welfare economics and has numerous applications in applied economics.

• The Pareto criterion cannot evaluate situations where some individuals gain while others lose, because such cases require interpersonal comparisons of utility, which Pareto and his followers rejected.

• Nicholas Kaldor and John Hicks developed the compensation principle to assess changes that make some people better off and others worse off.

  • They claimed that their criterion avoids interpersonal utility comparisons and explicit value judgments.

  • Their contribution became known as New Welfare Economics, which aimed to remain free from value judgments.

• Tibor Scitovsky and I. M. D. Little also made significant contributions to the development of New Welfare Economics.

• After New Welfare Economics, Abram Bergson and Paul Samuelson proposed the concept of the social welfare function, arguing that welfare economics cannot produce meaningful propositions without incorporating explicit value judgments.

• The Bergson–Samuelson social welfare function and Kenneth Arrow’s analysis of deriving a social welfare function from individual preferences represent further developments in welfare economics.

• Welfare economics remains a controversial field because it necessarily involves value judgments, over which economists often disagree sharply.

• The establishment of a welfare state is a fundamental objective of modern democratic governments, which seek to satisfy the wants of all individuals in society.

• Unsatisfied wants create pain, while satisfied wants generate pleasure and contribute to welfare; welfare is therefore viewed as the result of the satisfaction of wants.

• Increasing an individual’s welfare requires satisfying a greater number of his wants; comparing two periods, welfare is higher in the period during which more wants are satisfied.

• Conversely, welfare increases as the number of unsatisfied wants of a given intensity decreases, making the satisfaction of wants the central basis of individual welfare.