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Welfare Economics is a normative branch of economics that is concerned with the way economic activity ought to be arranged so as to maximize economic welfare. The hallmark of welfare economics is that policies are assessed exclusively in terms of their effects on the well-being of individuals. Welfare economics has been defined by Scitovsky as “That part of the general body of economic theory which is concerned primarily with policy.” So, what is the question of the topic we are going to discuss; What does Welfare Economics mean? Measuring and Value decisions!

Explain about Welfare Economics mean, Measuring Welfare, and their Value decisions!

Accordingly, whatever is relevant to individuals well-being is relevant under welfare economics, and whatever is unrelated to individuals well-being is excluded from consideration under welfare economics. Economists often use the term utility to refer to the well-being of an individual, and, when there is uncertainty about outcomes, economists use an ex-ante measurement of well-being, so-called expected utility.

Welfare economics employs value judgment s 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 judgments, which are dependent upon his or her attitudes, religion, philosophy and politics, and the economist has difficulty in aggregating these value judgments in advising policymakers about decisions that affect the allocation of resources (which involves making interpersonal comparisons of utility).

Definition of Welfare Economics:

The branch of economics called welfare economics is an outgrowth of the fundamental debate that can be traced back to Adam Smith, if not before. It is the economic theory of measuring and promoting social welfare.

In The Wealth of Nations, Book IV, Smith wrote:

“Every individual necessarily labors to render the annual revenue of the society as great as he can. He generally indeed neither intends to promote the public interest nor knows how much he is promoting it…. He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

J. De V. Graff,

“The proof of the pudding is indeed in the eating. The welfare cake, on the other hand, is so hard to taste, that we must sample its ingredients before baking.”

R.W. Emerson, Work and Days,

“The greatest meliorator of the world is selfish, huckstering trade.”

The literature on welfare economics has grown rapidly in recent years. The utilitarians were the first to talk of welfare in terms of the formula, ‘the greatest happiness of the greatest number’. Vilfredo Pareto considered the question of maximizing social welfare on the basis of general optimum conditions.

Marshall and Pigou, the neo-classical economists, concentrated on particular sectors of the economic system in their postulates of welfare economics. It was Professor Robbins’ ethical neutrality view about economics that led to the development of welfare economics as an important field of economic studies. Kaldor, Hicks, and Scitovsky have laid the foundations of the New Welfare Economics with the help of the ‘compensation principle’ avoiding all value judgments.

On the other hand, Bergson, Samuelson, and others have developed the concept of the Social Welfare Function without sacrificing value judgments. In the discussion that follows we shall refer to certain basic concepts of welfare economics and then pass on to Pareto’s welfare conditions for an understanding of modern welfare economics.

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Explanation of Welfare Economics:

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 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 judgment influenced by the preferences and priorities of those making the judgment. This led to a search for welfare criteria, which avoided making interpersonal comparisons of utility by introducing explicit value judgments 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.

Pareto optimality is thus a dominance concept based on comparisons of vectors of utilities. It rejects the notion that utilities of different individuals can be compared, or that utilities of different individuals can be summed up and two alternative situations compared by looking at summed utilities. When ultimate consumers do not appear in the model, as in the pure production framework, a situation is said to be Pareto optimal if there is no alternative that results in the production of more of some output, or the use of less of some input, all else equal.

Obviously saying that a situation is Pareto optimal is not the same as saying it maximizes GNP, or that it is best in some unique sense. 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. There are generally many Pareto optimal.

However, optimality is a common good concept that can get common assent: No one would argue that society should settle for a situation that is not optimal because if A is not optimal, there exists a B that all prefer. 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:
  • Efficiency gains/losses, and.
  • 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.

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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.

How to Measuring Welfare?

There are mainly two concepts for measuring welfare. The first relates to a Pareto improvement whereby social welfare increases when society as a whole is better off without making any individual worse off. This proposition also includes the case that when one or more persons are better off, some persons may be neither better off nor worse off. It is, thus, free from making interpersonal comparisons.

Hicks, Kaldor and Scitovsky have explained social welfare in the Paretian sense in terms of ‘the compensation principle’. In the second place, social welfare is increased, when the distribution of welfare is better in some sense. It makes some persons in society better off than others so that the distribution of welfare is more equitable. Also study, Why Entrepreneurs Required the Capital? to Pursue Business!

This is known as distributional improvement and relates to the Bergson social welfare function. Dr. Graaf, however, refers to another concept which he calls the paternalist concept. A state or a paternalist authority maximizes social welfare according to its own notion of welfare without any regard to the views of individuals in society.

Economists do not make use of this concept to measure social welfare because it is related to a dictatorial regime and does not fit in a democratic set-up. Economic welfare, thus, implies social welfare which is concerned primarily with the policy that leads either to a Pareto improvement or distributional improvement, or both.

What does Welfare Economics mean Measuring and Value decisions
What does Welfare Economics mean? Measuring and Value decisions! Image credit from #Pixabay.

Value Decisions in Welfare Economics:

The following Value Judgments or Decisions below are:

Alt ethical judgments and statements which perform recommendatory, influential and persuasive func­tions are value judgments. According to Dr. Brandt a judgment is a value judgment if it entails or contradicts some judgment which could be formulated so as to involve any one of the following terms in an In ordinary sense: “Is a good thing that” or “Is a better thing that”, “Is normally obligatory”, “Is reprehensible”, and “Is normally praiseworthy”.

Value judgments describe facts in an emotive way and tend to influence people by altering their beliefs or attitudes. Such statements as “This change will increase economic welfare”, “Rapid economic development is desirable”, “Inequalities of incomes need be reduced”, are all value judgments. Welfare is an ethical term. So all welfare propositions are also ethical and involve value judgments.

Such terms as “Satisfaction”, “Utility” are also ethical in nature since they are emotive. Similarly, the use of a highly emotive word as “social”, “community” or “national” in place of “economic” is ethical. Since welfare economics is concerned with policy measures, it involves ethical terminology, such as the increase of “social welfare” or “social advantage” or “social benefit”. Thus welfare economics and ethics cannot be separated.

They are inseparable, according to Prof. Little, “because the welfare terminology is a vague terminology. Since welfare propositions involve value judgments, the question arises whether economists should make value judgments in economics.” Economists differ over this issue. The neo-classical were concerned with the measurability of utility and the inevitable interpersonal comparisons of utility.

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Pigou’s income-distribution policy, based on Marshall’ postulate of equal capacity for satisfaction, implied that interpersonal comparisons of utility were possible. Robbins, in 1932, led a frontal attack against this view. He maintained that if economics was to be an objective and scientific study, economists should refrain from making interpersonal comparisons, for policy recommendations tend to make some people better off and others worse off.

It is, therefore, not possible to make interpersonal comparisons, i.e. the welfare of one person cannot be compared with that of another. The majority of economists agreeing with Robbins switched over to the Paretian ordinal method in order to avoid interpersonal comparisons of utility. Kaldor, Hicks, and Scitovsky formulated the ‘compensation principle’ free from value judgments.

Accordingly, economists can make policy recommendations on the basis of efficiency considerations. The objective test of economic efficiency is that the gainers from a change can more than compensate the losers. But this test of increased efficiency implies a value judgment because the gainers from a change are able to compensate the losers.

The very idea of compensation involves value prescriptions. So even the formulators of the ‘New Welfare Economics’ have not been successful in building value-free welfare economics. Prof. Bergson also agrees with Robbins that interpersonal comparisons involve value judgments. But he along with Samuelson and Arrow holds that no meaningful propositions can be made in welfare economics without introducing value judgments.

Welfare economics, thus, becomes a normative study which, however, does not prevent economists from studying it scientifically. Even the Paretian general optimum theory is not value-free. It states that an optimum position is one from which it is not possible to make everyone better off without making at least one person worse off, even by re­allocation of resources. This welfare proposition contains certain value judgments.

The Paretian optimum is related to the welfare of the individual. In order to attain the optimum position every individual act as the best judge of his welfare. If any re-allocation of resources makes at least one person better off without making others worse off, then the welfare of the society is said to have increased. These are all value judgments which Pareto could not avoid despite the fact that he used the method of ordinal measurement of utility.

Boulding’s view merits consideration in this controversy:

“Whatever may be the case in the Elysian Fields of pure economics, the social fact is that we make… interpersonal comparisons all the time, and that hardly any social policy is possible without them, for almost every social policy makes some people worse-off and some better-off. The Paretian optimum itself is a special case of a social welfare function, for if we assume this to be a social ideal it implies that nobody should ever be made worse-off, whereas most societies have defined certain groups (e.g., criminals or foreigners) who should be made worse off…”

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