Welfare Economics

1
Welfare Economics

• ??? ??? Theo Karim

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Welfare Economics

• Welfare economics is a branch of economics that
  uses microeconomic techniques to evaluate
  economic well-being, especially relative to
  competitive general equilibrium within an economy
  as to economic efficiency and the resulting
  income distribution.
• ???????Vilfredo Pareto
• ???????Arthur Cecil Pigou
• ????????Ludwig von Mises
• ????????Oskar Ryszard Lange
• ????????Kenneth Joseph Arrow
• ??????James M. Buchanan

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Vilfredo Pareto

• Vilfredo Pareto(15 July 1848 19 August 1923) An
  Italian engineer, sociologist, economist,
  political scientist and philosopher. He made
  several important contributions to economics,
  particularly in the study of income distribution
  and in the analysis of individuals' choices.

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Pareto efficiency

• Pareto Optimality
• In a Pareto efficient economic allocation, no one
  can be made better off without making at least
  one individual worse off.
• Pareto improvement
• Given an initial allocation of goods among a set
  of individuals, a change to a different
  allocation that makes at least one individual
  better off without making any other individual
  worse off is called a Pareto improvement.

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Requirements of Pareto Efficiency

• Pareto optimality in consumption
• MRSaxyMRSbxy
• Pareto optimality in production
• MRTSAlkMRTSBlk
• Pareto optimality in both
• MRTxyMRSxy

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• Welfare economics' first law
• Perfect competition of market economy in general
  equilibrium is Pareto optimal.
• competitive market mechanism can ensure that
  Pareto efficient allocation realized.

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• Welfare economics' second law If a certain
  social resource allocation situation while meet
  the Pareto optimality, but this kind of
  distribution is not very fair, the government
  could begin to intervene for income transfer then
  back to the competitive market mechanism, can
  also achieve the Pareto optimality.

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Arthur Cecil Pigou

• Arthur Cecil Pigou (18 November 1877 7 March
  1959) was an English economist. As a teacher and
  builder of the school of economics at the
  University of Cambridge. His work covered various
  fields of economics, particularly welfare
  economics.

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Main Publications

• ?????????(1905)
• ?????(??????) (1912)
• ?????(1914)
• ????(1927)
• ??????(1925,1956)
• ????(1933)
• ????????????(1937)
• ?????(1935)
• ?????(1945)
• ????(1946)
• ????????(1956)

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Pigous economic welfare

• Ideological basis
• Bentham the utilitarianism of philosophy
• Personal welfare is the sum of the meet
• And the social welfare is the sum of personal
  welfare
• Theoretical basis
• Radix number of marginal utility value theory

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Pigous economic welfare

• Pigou divided the welfare into two classes
• The social welfare
• The economic welfare
• And Pigou focus on the economic welfare

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Pigous economic welfare

• PART 1Welfare and national income
• PART 2The distribution in different uses of the
  quantity and resources of national income
• PART 3National income and labor
• PART 4The distribution of national income

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Pigous economic welfare

• Pigou, justify equal distribution of income
  mainly on the ground of diminishing marginal
  utility, assuming equal capacity to enjoy income.
  Abstracting away such questions as incentive
  effects, that equal distribution maximises total
  utility

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Pigous economic welfare

• Pigou has two propositions in welfare economic
• For a person's actual income of any increase, can
  make the meet increase
• Transfer the rich man's money income to the poor
  can gratify them.

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Pigous economic welfare

• Transfer income policy Suggestions
• From rich
• voluntary(charity)
• Compulsory(tax)
• To poor
• Direct social insurance and services
• Indirect subsidies to necessary production
  department

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Pigous economic welfare

• Method Marginal output value analysis
• Premise Perfect competitive market
• Put forward two concepts
• Marginal private net output
• Marginal social net ouput

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Pigous economic welfare

• Optimal distribution condition
• pure Marginal private output
• pure Marginal social output
• The marginal social net output are identical in
  each production department

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Pigous economic welfare

• The necessity of state intervention
• It is objective that the marginal private net
  output and marginal social net output would
  deviate from the equilibrium level
• The method of state intervention
• Subsidies
• Tax

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Ludwig Von Mises ????????
29 September 1881 10 October 1973 He was a
prominent figure in the Austrian School of
economic and is best known for his work on
praxeology.
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1881 born in a wealthy Jewish family 1900
attended the University of Vienna 1906 awarded
his doctorate from the school of law. 19131934
privatdozent at the Vienna University in the
years 19091934 secretary at the Vienna Chamber
of Commerce 1934 moved to Switzerland 19341940
a professor of the Graduate Institute of
International Studies 1940 moved to New York City
19451969 visiting professor at New York
University. 1973 died in New York City at age of
92
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Major work
Human Action ???? Socialism
???? Liberalism ???????? The Theory of
Money and Credit ??????? Bureaucracy
???? The Anti-Capitalistic ????????
22
Many of his works, including Human Action, were
on two related economic themes First,monetary
economics and inflation (Business cycle
theory) Second,the differences
between government controlled economies and free
markets.
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"Economic Calculation in the Socialist
Commonwealth" (1920)

1. The socialist government interference can not be
   pricing rationally.
2. With the development of free market, private
   capital investment is the only way to prosperity
   and growth of economic.
3. The functions of government are limited to the
   protection of private property and legal sanctions

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Liberalism
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25
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26
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27
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28
Friedrich August Hayek ?????A???

1. 18991992
2. student and follower of Mises, and he was the
   representative of the neo-liberalism

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Oskar Ryszard Lange  ???R??
1.July 27, 1904   October 2, 1965 2.a Polish
economist and diplomat. 3.He was most known for
advocating the use of market pricing tools in
socialist systems and providing a model of market
socialism.
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1904 born in Tomaszów Mazowiecki. (??????) 1926
studied law and economics at University of
Krakow, where he received a B.A. 1928 got a
Masters of Law . 19261927 worked at the Ministry
of Labor in Warsaw. This was followed by a
research assistantship at the University of
Krakow. 1934 a Rockefeller fellowship brought
him to England. 1937 emigrated to the United
States in. He then became a professor at the
University of Chicago in 1938. 1945 returned to
Poland. 19611965 was deputy chairman of the
Polish Council of State. 1965 died
31
Lange Model
The Lange model suggests three levels of
decision-making. Firms and households represent
the lowest level, with industrial ministries as
the intermediate level, and the highest level of
decision-making is made up of the central
planning board.
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trial-and-error method.
If a surplus in the supply of a particular good
arises, the central planning board lowers the
price of that good. Likewise, if there is a
shortage of a particular good, the price is
raised by the central planning board. This
process of price adjustments takes place until
equilibrium between supply and demand is met.
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Advantages

1. Governments can control the input factors and
   decide social dividends. These will make the
   distribution of income better than capitalism.
2. Governments can control the investment ratio, so
   that the country can control the speed of
   economic growth.

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3.Governments can control the prices of
resources, which can prevent undesirable
environmental impact. 4.Governments can control
the savings and investment. And this is
beneficial to reduce of cyclical instability.
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Criticisms

• This model was developed in response to Ludwig
  von Mises and Friedrich Hayeks criticisms of
  socialism, stating that the state does not have
  the knowledge to calculate general equilibrium
  prices, and that market prices were essential for
  the state to allocate resources.

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2.The primary criticism against socialism is that
it could not direct investment efficiently
without speculation in financial markets .
socialist officials cant simulate the pricing of
future capital goods in financial markets.
3.Incentive mechanism has a serious problem.
They cant make everyone in this model take their
duties and make the right decision.
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Conclusion
Planned economy can not solve the allocation
problem of resources
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Public choice theory Intrisinc connection with
welfare economics
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James Buchanan
Ph.D. from the University of Chicago in 1948,
influenced by Frank H. Knight. Found enlightening
the work of Knut Wicksell.  Founder of a
new Virginia school of political economy. He
taught at the University of Virginia, where he
founded the Thomas Jefferson Center for the
Protection of Free Expression  UCLA  Florida
State University the University of Tennessee
Virginia Polytechnic Institute ("Virginia
Tech"), where he was affiliated with the Center
for the Study of Public Choice (CSPC). In 1983,
he followed CSPC to its new home at George Mason
University. In 2001 Buchanan was honoured with an
honorary doctoral degree at Universidad Francisco
Marroquín due his contribution to economic
theory. Buchanan's work includes extensive
writings on public finance, the public debt,
voting, rigorous analysis of the theory of
logrolling, macroeconomics, constitutional
economics and libertarian theory. Nobel Prize in
1986 for his work on public choice
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Bibliography
Public Principles of Public Debt A Defense and
Restatement, by James M. Buchanan, at the Library
of Economics and Liberty The Calculus of Consent
Logical Foundations of Constitutional
Democracy, by James M. Buchanan and Gordon
Tullock, at the Library of Economics and
Liberty Public Finance in Democratic Process
Fiscal Institutions and Individual Choice, by
James M. Buchanan, at the Library of Economics
and Liberty The Demand and Supply of Public
Goods, by James M. Buchanan, at the Library of
Economics and Liberty Cost and Choice An Inquiry
in Economic Theory, by James M. Buchanan, at the
Library of Economics and Liberty The Limits of
Liberty Between Anarchy and Leviathan, by James
M. Buchanan, at the Library of Economics and
Liberty Democracy in Deficit The Political
Legacy of Lord Keynes, by James M. Buchanan
and Richard E. Wagner, at the Library of
Economics and Liberty The Power to Tax
Analytical Foundations of a Fiscal
Constitution, by Geoffrey Brennan and James M.
Buchanan, at the Library of Economics and
Liberty The Reason of Rules Constitutional
Political Economy,
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Background

• Consideration of the state as an agent outside
  the scope of economic theory, whose actions
  depend on different considerations than those
  driving economic agents
• Context of democracy

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Public Choice Theory

• Buchanan Public Choice is nothing more than
  common sense, as opposed to romance. To some
  extent, people then and now think about politics
  romantically. Our systematic way of looking at
  politics is nothing more than common sense.

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Hardins   "back of the Invisible Hand "

• "One may sense, however, that all too often we
  are less helped by the benevolent invisible hand
  than we are injured by the malevolent back of
  that hand that is, in seeking private interests,
  we fail to secure greater collective interests.
  The narrow rationality of self-interest that can
  benefit us all in market exchange can also
  prevent us from succeeding in collective
  endeavors."

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Assumption

• Politicians and bureaucrats are individuals who
  act based on a budget-maximizing model in a
  self-interested way for the purpose of growing
  their own power and influence.
• Buchanan rejects "any organic conception of
  the state as superior in wisdom, to the
  individuals who are its members."

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Budget Maximization Model

• Rational bureaucrats will always and everywhere
  seek to increase their budgets in order to
  increase their own power, thereby contributing
  strongly to state growth and potentially reducing
  social efficiency.
• Example bureaucrat who heads a public
  administration department, and who will try to
  maximize the department's budget, thus increasing
  its salary and prestige.

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Public choice theory

• Public choice theory is the use of
  modern economic tools to study problems that
  traditionally are in the province of political
  science. From the perspective of political
  science, it is the subset of positive political
  theory that models voters, politicians, and
  bureaucrats as mainly self-interested

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Public choice theory

• Goal How to ensure that the most effective
  policies earn better chance of being implemented
  (how to choose the politicians and bureaucrats,
  what sanction system and provide rewards, etc.)..

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Governments Failure

• Democracies produce less "good" than optimum
  decisions due to ignorance and indifference
  rational voters.
• Weak power of individuals to influence the
  outcome, the effort required to learn to vote
  with full knowledge himself is considerable.
• rational choice of the voter is to remain in
  ignorance, or to abstain.

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Governments Failure

• Special interests that could gain an advantage by
  forcing the government to adopt decisions
  generally harmful, but profitable for them.
• Invisible prejudice because very small. Profits
  are shared among a small minority, whose concern
  becomes to perpetuate this type of decision.
• For example, protectionist measure in the textile
  industry

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Governments Failure

• Theory of fiscal illusion
• The essential violence of redistribution policy,
  which distorts the perception of its nature and
  its effects, both for policy makers and for their
  victims.

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Governments Failure

• The public choice theory explains that many
  harmful decisions will be taken by a majority
  anyway. It speaks of "government failure" as a
  mirror of "market failure" commonly used in
  public economics the failure in optimal
  allocation of resources, goods and services.

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Impact limitations of this theory

• Nobel prize winner Sen
• Can you direct me to the railway station? asks
  the stranger. "Certainly," says the local,
  pointing in the opposite direction, towards the
  post office, "and would you post this letter for
  me on your way?" "Certainly," says the stranger,
  resolving to open it to see if it contains
  anything worth stealing.

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Impact limitations of this theory

• James Buchanan
• even if the model with its rational
  self-interest assumptions proves to be useful in
  explaining an important element of politics, it
  does not imply that all individuals act in
  accordance with the behavioral assumption made or
  that any one individual acts in this way at all
  times the theory of collective choice can
  explain only some undetermined fraction of
  collective action. However, so long as some part
  of all individual behavior is, in fact,
  motivated by utility maximization, and so long as
  the identification of the individual with the
  group does not extend to the point of making all
  individual utility functions identical, an
  economic-individualist model of political
  activity should be of some positive worth

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Hayek and Buchanan

• http//hayek.ufm.edu/index.php/James_Buchanan

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Kenneth Joseph Arrow Impossibility Theorem and
General Equilibrium linked to welfare Economics
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Kenneth Joseph Arrow

• Kenneth Joseph Arrow was born in New York City on
  August 23, 1921
• He earned a Bachelor of Science degree in Social
  Science from the City College of New York in 1940
• At Columbia, he received a Master's degree in
  Mathematics in 1941 and a Ph.D. in Economics in
  1951
• In 1949, he was appointed Acting Assistant
  Professor of Economics and Statistics at Stanford

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Kenneth Joseph Arrow

• In 1968, Arrow moved to Harvard to be the
  Professor of Economics.
• Arrow was awarded the John Bates Clark Medal of
  the American Economic Association in 1957.
• He was elected president of the American Economic
  Association in 1972.
• Arrow has also been a member of the National
  Academy of Sciences and the American Statistical
  Association.

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Main Works

• Arrow, Kenneth J., (1951b, 2nd ed. 1963). Social
  Choice and Individual Values, Wiley, New York.
• Arrow, Kenneth J. and Gérard Debreu (1954).
  Existence of a Competitive Equilibrium for a
  Competitive Economy. Econometrica (Econometrica,
  Vol. 22, No. 3) 22 (3)
• Arrow, Kenneth J., 1959a, "Functions of a theory
  of behaviour under uncertainty" Metroeconomica,
  11 12-20
• Arrow, Kenneth J. (1963). "Uncertainty and the
  Welfare Economics of Medical Care". American
  Economic Review, 53 (5).
• Arrow, Kenneth J., 1968, "Economic Equilibrium."
  In D. L. Sills (ed.) International Encyclopedia
  of the Social Sciences 4 37688. London and New
  York Macmillan and the Free Press.
• Arrow, Kenneth J. (1987). "Rationality of self
  and others in an economic system" in R. M.
  Hogarth and M. W. Reder (eds.), Rational Choice.
  Chicago The University of Chicago Press.
• Arrow, Kenneth J. (1994). "Methodological
  Individualism and Social Knowledge", American
  Economic Review, 84(2).
• Kenneth J. Arrow and Gérard Debreu, ed.
  (2002)Landmark Papers in General Equilibrium
  Theory, Social Choice and Welfare, Edward Elgar
  Publishing.

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Contributions to Economics

• Arrow is considered, along with Paul Samuelson,
  one of the founders of modern neo-classical
  economics
• His most significant works are his contributions
  to social choice theory, notably "Arrow's
  Impossibility Theorem" and his work on General
  Equilibrium analysis
• He has also provided foundational work in many
  other areas of economics, including Endogenous
  Growth Theory and Information Economics
• In 1972, he won the Nobel Memorial Prize in
  Economics at the age of 51, becoming the youngest
  ever recipient for the award

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Arrow's Impossibility Theorem

• Social Choice and Individual Values was Arrows
  doctoral dissertation which derives from his Ph.D
  thesis, published as a Cowles Commission
  monograph.
• The theorem has tremendous implications for
  welfare economics and theories of justice.
• As perhaps the most important of Arrow's many
  contributions to welfare theory appears in his
  "impossibility theorem", according to which it is
  impossible to construct a social welfare function
  out of individual preference functions.
• General Impossibility Theorem It is impossible
  to formulate a social preference ordering that
  satisfies all of the following conditions

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Arrow's Impossibility Theorem

• Non-dictatorship The preferences of an
  individual should not become the group ranking
  without considering the preferences of others.
• Individual Sovereignty each individual should be
  able to order the choices in any way and indicate
  the links between them
• Unanimity If every individual prefers one choice
  to another, then the group ranking should do the
  same
• Freedom From Irrelevant Alternatives If a choice
  is removed, then the others choices order should
  not change, for every individual
• Uniqueness of Group Rank The method should yield
  the same result whenever applied to a set of
  preferences. The group ranking should be
  transitive.

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Arrow's Impossibility Theorem

• Example
• Suppose we wanted to find the social preference
  for the three ice cream flavours, vanilla,
  chocolate and strawberry
• NB A set of preferences are said to be rational
  or transitive if when A is preferred to B and B
  is preferred to C then A is preferred to C.

Group Vanilla Chocolate Strawberry
X 1 2 3
Y 2 3 1
Z 3 1 2
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Arrow's Impossibility Theorem

• Results
• In a choice between vanilla and chocolate,
  the X groups would vote for vanilla, the Y group
  would also vote for vanilla and the Z group would
  vote for chocolate
• gt So, vanilla would win two-thirds of the
  votes and we could say that vanilla is socially
  preferred to chocolate
• In a choice between chocolate and
  strawberry the X group would vote for chocolate,
  the Y group would vote for strawberry and the Z
  group would vote for chocolate
• gt So, chocolate would win and chocolate is
  preferred to strawberry
• Consider a social choice by majority voting
  between vanilla and strawberry
• The X group would vote for vanilla, the Y
  group would vote for strawberry and the Z group
  would vote for strawberry
• gt So, strawberry is socially preferred to
  vanilla

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General Equilibrium Theory

• Sir John Hicks and of Professor Kenneth Arrow
  have opened up new productive paths for research
  in General Equilibrium area and thereby made
  fundamental contributions to the renewal of the
  theory.
• Through Arrow's reformulation, which was based on
  the mathematical theory of convex sets, the
  general equilibrium theory gained both in
  generality and in simplicity
• From general equilibrium theory to welfare theory
  is but a short step, and both Hicks and Arrow
  have, on several points, developed the welfare
  economic consequences of their achievement.
• In its new form, this concept has had a great
  impact, i.e., within the cost-benefit analysis.

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Arrow-Debreu General Equilibrium Theory

• The Arrow-Debreu proof of the existence of a
  Walrasian equilibrium for an economy proceeds by
  3 steps
• (1) Associating a generalised game with the
  economy
• (2) Proving that there exists at least one
  equilibrium of the generalised game
• (3) Demonstrating that in an equilibrium of the
  generalised game all markets in the economy clear
• The Arrow-Debreu proof, unlike the proofs that
  work via the construction of an excess-demand
  function, is relatively easily modified to take
  into account all of these ingredients.

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Uncertainty and the welfare economics

• In 1963, Kenneth Arrow published "Uncertainty and
  the welfare economics of medical care" in The
  American Economic Review.
• This paper became not only one of the most widely
  cited articles in the field of health economics
  but also a source of reference in other fields
  (i.e. second-hand assets, online auctions and
  insurance)
• Arrow writes that non-market institutions can
  (but not necessarily do) enhance the efficiency
  of the medical care system.
• In this respect, he cautions against viewing all
  efforts by physicians to ration entry to medical
  schools or to require professional licensing as
  mere ruses to raise their incomes.