Welfare economics
Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society. This evaluation is typically done at the economy-wide level,[1] and attempts to assess the distribution of resources and opportunities among members of society.
The principles of welfare economics are often used to inform public economics, which focuses on the ways in which government intervention can improve social welfare. Additionally, welfare economics serves as the theoretical foundation for several instruments of public economics, such as cost–benefit analysis. The intersection of welfare economics and behavioral economics has given rise to the subfield of behavioral welfare economics.[2]
Two fundamental theorems are associated with welfare economics. The first states that competitive markets, under certain assumptions, lead to Pareto efficient outcomes.[3] This idea is sometimes referred to as Adam Smith's invisible hand.[4] The second theorem states that with further restrictions, any Pareto efficient outcome can be achieved through a competitive market equilibrium,[3] provided that a social planner uses a social welfare function to choose the most equitable efficient outcome and then uses lump sum transfers followed by competitive trade to achieve it.[3][5] Arrow's impossibility theorem which is closely related social choice theory, is sometimes considered a third fundamental theorem of welfare economics.[6]
Welfare economics typically involves the derivation or assumption of a social welfare function, which can then be used to rank economically feasible allocations of resources based on the social welfare they generate. Such functions often include measures of economic efficiency and equity, as well as other measures such as economic freedom as described in the capability approach.
Criteria[edit]
Efficiency[edit]
Situations are considered to have distributive efficiency when goods are distributed to the people who can gain the most utility from them.
Pareto efficiency is an efficiency goal that is standard in economics. A situation is Pareto-efficient only if no individual can be made better off without making someone else worse off. An example of an inefficient situation would be if Smith owns an apple but would prefer to consume an orange while Jones owns an orange but would be prefer to consume an apple. Both could be made better off by trading.
A pareto-efficient state of affairs can only come about if four criteria are met:
Criticisms[edit]
Some, such as economists in the tradition of the Austrian School, doubt whether a cardinal utility function, or cardinal social welfare function, is of any value. The reason given is that it is difficult to aggregate the utilities of various people that have differing marginal utility of money, such as the wealthy and the poor.
Also, the economists of the Austrian School question the relevance of Pareto optimal allocation considering situations where the framework of means and ends is not perfectly known, since neoclassical theory always assumes that the ends-means framework is perfectly defined.
The value of ordinal utility functions has been questioned. Economists have proposed other means of measuring well-being as an alternative to price indices like willingness to pay using revealed or stated preference method. This includes
subjective well-being functions based on individuals' ratings of their happiness or life satisfaction rather than on their preferences.[11]
Price-based measures are seen as promoting consumerism and productivism by many. It is possible to do welfare economics without the use of prices; however, this is not always done. Value assumptions explicit in the social welfare function used and implicit in the efficiency criterion chosen tend to make welfare economics a normative and perhaps subjective field. This can make it controversial. However, perhaps most significant of all are concerns about the limits of a utilitarian approach to welfare economics. According to this line of argument, utility is not the only thing that matters and so a comprehensive approach to welfare economics should include other factors.
The capability approach is a theoretical framework that entails two core normative claims: first, the claim that the freedom to achieve well-being is of primary moral importance, and second, that freedom to achieve well-being is to be understood in terms of people's capabilities, that is, their real opportunities to do and be what they have reason to value.[12]