Welfare Economics:

Concept, Approaches and Problems

Ramindra Suwal
M. Sc. Ag 1stSemester
Roll No.: R-2018-AEC-15M
 Welfare economics
• Welfare economics is a branch of study that
endeavors to formulate propositions that enable
us to state that social welfare in one economic
situation is greater or lesser than in another.
• ‘Theoretical welfare economics is . . . that branch
of study which endeavors to formulate
propositions by which we may rank, on the
scale of better or worse, alternative economic
situations open to society.’-Mishan (1969b, p. 13)
 Welfare economics Contd…
• Social welfare can be defined as a vector of individual welfares:
• W =W (W1, W2,..., W I ) (1.1a)
• Where W i is the welfare of the ith individual and I is the relevant
number of individuals.
• Here individual welfare can be taken as an individual’s well-
being, or more explicitly, his or her happiness, with happiness
subsuming both sensual pleasure and pain and spiritual delight and
suffering.
• Alternatively we can define social welfare as a vector of individual
(ordinal) utilities. One way or another, we have
• W=(U1,U2,...,UI), (1.1b)
• Where Ui is a utility function representing the ordinal preference of
individual i. A vector is said to be larger than another if and only if
some of its elements are larger than and none of its elements is
smaller than the corresponding elements of the other vector.
 Social welfare function:
• welfare of society to the utility levels of individuals and is
used in evaluating the effects of changes in the quality or
quantity of environmental goods.
• Johansson (1987) notes that this welfare function is
generally assumed to have three major properties.
• First, an increase in the utility of one individual, when the
utility of all other individuals remains constant, increases
social welfare.
• Second, if there is a reduction in the utility of one
individual, there must be an increase in the utility
experienced by another for social welfare to remain
constant.
• Third, the weight given to the welfare of an individual is
linked to his or her utility level – that is, weights can be
applied to account for distributional considerations.
• A social welfare function is necessary to
identify the optimal resource allocation
from among the Pareto-efficient allocations.
• That allocation of a society’s resources,
pattern of production and distribution of
output which is the 'best' attainable
according to some stated set of objectives.
• In the diagram below, we
have a two-person
community. The line u-u
represents, in terms of each
individual's UTILITY or well-
being the various,
alternative Pareto optimal
points possible while the w-
w lines represent
combinations of individual
utility which give rise to
equal levels of social
welfare. Higher w-w lines
indicate higher levels of
social welfare. The point S is
the highest attainable level
of social welfare and thus is
the social optimum.
 DIFFERENT CONCEPT AND MEASUREMENT
CRITERION OF SOCIAL WELFARE

• 1) Growth of GNP as a criterion of welfare:

economic growth results the increase of social
welfare because growth increased
employment and the goods available for
consumption to the community. This criterion
highlights the importance of efficiency in
social welfare.
 2) Bentham’s criterion

This criterion assumes that the total welfare is the

sum of the utilities of the individual of the
society. Let A, B, C are the individuals of a society.
So,
W = UA + UB + UC
According to Bentam, WΔ > 0, if Δ UA+ Δ UB + Δ UC
> 0.
Suppose A and B’s utilities are increased with
decreased C’s utility, but Δ UA+ Δ UB > Δ UC.
Here, two individuals A and B are better off while
C is worse-off after the change have taken place.
 3) Cardinalist Criterion

• 3) Cardinalist Criterion
• based on diminishing law of marginal
utility.
• welfare can be maximized if income is
equally distributed among all members
of the society.
 Bergson’s Social Welfare Criterion

• based on explicit value judgment which enables

the analyst to evaluate the situation.
• According to Bergson, the value judgment may be
explicitly formed in the form of a social welfare
function.
• A social welfare function is an indifference map
which ranks different combinations of individual
utility according to a set of explicit value
judgment about the distribution of income.
• Social welfare function is similar to the utility
function of a consumer.
 Bergson-Samuelson
Individualistic Social Welfare Function
• Ranks social outcomes in terms of how individuals view
personal well-being at each possible outcome

• Each outcome provides individuals with different levels of

utility
→ Some individuals will receive more; some will receive less
• The social welfare function ranks outcomes by the effect such
changes have on overall welfare received by a society

• Defines a set of ethical rankings that define a set of social

indifference curves
• social welfare function is
an ordinal index of
welfare of the society
and is a function of the
utility levels of all
individual members.
• W = f (U1, U2, …,Un)
• where, W = Social
welfare
• U1, U2, …,Un = Utility
index of an individual .
 Assumptions:
• The Bergson social welfare function is based on
certain assumptions:
(a) It assumes that social welfare depends on each
individual’s wealth and income and each individual’s
welfare depends, in turn, on his wealth and income
and on the distribution of welfare among the
members of the society.
(b) It assumes the presence of external economies
and diseconomies with their consequent effects.
(c) It is based on ordinal ranking of combinations of
those variables which influence individual welfare.
(d) Interpersonal comparisons of utility involving value
judgments are freely permissible.
 It’s Criticism:
(1) Not Applicable either to a Totalitarian State
or a Democratic One:
(2) Construction of Welfare Function Difficult:
(3) Arbitrary and Imaginary:
(4) The Concept of “Maximum “ without any
Empirical Significance:
(5) Contradictory Results:
(6) Not Helpful in Solving Problems:
Hicks - Kaldor Compensation Principle

• Kaldor’s Criterion: Allocation X is socially

preferable to allocation Y, if those who gain from
X could compensate the losers, and still be better
off.
• Hick’s Criterion: Allocation X is socially
preferable to allocation Y, if those who lose from
X, cannot bribe the gainers into not making the
change from Y to X.
 The Kaldor-Hicks Criterion
Assumptions:
(a) Each individual’s satisfactions are independent
from the others so that he is the best judge of his
welfare.
(b) There is the absence of external effects in
production and consumption.
(c) The tastes of each individual are constant.
(d) It is possible to separate the problems of
production and exchange from the problem of
distribution.
(e) It is assumed that utility is measured ordinarily
and interpersonal comparisons are impossible.
 Kaldor-Hicks Compensation Criterion

• “if gainers of a proposed economic change

evaluate their gains as G and losers evaluate
their losses as L, and if G>L, then gainers
would be able to compensate the losers and
yet retain a net gain. Under this condition, the
proposed change will increase the social
welfare.
 Its Criticism:
This compensation criterion has been criticised by
Scitovsky, Baumol, Samuelson, Little and others.
1. Ignores income distribution:
2. Measures only potential welfare:
3. No common standard of value:
4. Not free form Interpersonal Comparisons:
5. Based on Long-Run Welfare Adjustments:
6. Does not Involve Actual Compensation:
7. No Universal Validity:
 6) The Pareto-optimality Criterion

• According to Pareto criterion, any change

that makes at least one person better-off
without making someone else worse-off
makes definitely an improvement in
social welfare.
• Conversely, any change that makes at
least one person worse-off and no one
better-off causes a decrease in the social
welfare.
• Following marginal conditions must be
satisfied:
1. Efficiency of distribution of commodities
among consumers (efficiency in exchange)
2.Efficiency of the allocation of factors among
firms/producers (Efficiency of production)
3.Efficiency in the allocation of factors among
commodities (efficiency in the product-
mix/composition of output)
• 7) The theory of Second Best
• by Richard G. Lipsey and Kelvin Lancaster,
• When one or more of the first order
conditions of Pareto optimality are not
fulfilled for some reasons, the remaining
conditions can be satisfied to have a solution
as close as possible to the Pareto optimality.
This is known as theory of second best. The
greater the number of conditions of satisfied,
the closer would be the solution to Pareto
optimality.
Thank
you