WELFARE ECONOMICS

Welfare

In ordinary means the health, happiness, and fortunes of a person or group or society or
state. In other words, it is a statutory procedure or social effort designed to promote the basic
physical and material well-being of people in need.

Welfare refers to a range of government programs that provide financial or other aid to
individuals or groups who cannot support themselves. Welfare programs are typically funded
by taxpayers and allow people to cope with financial stress during rough periods of their lives.

Welfare is a type of government support intended to ensure that members of a society

can meet basic human needs such as food and shelter. In a welfare state, the State assumes
responsibility for the health, education, and welfare of society, providing a range of social
services such as those described.

Welfare economics

The study of optimal allocation of resources and their effect on social welfare is known
as welfare economics

Economics as basis of social welfare

Economics is to study human activities which are conductive which are conductive to
human welfare in its material aspect. Wealth furnishes man with material means of satisfying
his wants and of promoting his welfare. Economists, in so far as they study wealth, can be
legitimately regarded as studying causes of material welfare. The range of our enquiry becomes
restricted to that part of social welfare. Welfare can be divided as ‘Individual Welfare’ and
‘Social Welfare’ and again as ‘General Welfare’ and ‘Economic Welfare’.

Individual welfare and Social welfare:

Individual welfare refers to the sum-total of satisfaction derived by an individual from

the consumption of economic goods. Individual satisfaction is linked with individual choice.
He chooses the combination which gives him the maximum satisfaction. Social welfare is an
aggregate of the utilities or satisfaction of all the individuals in the society. The welfare of all

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the individuals is synonymous with the welfare of the society. The object of social welfare is
to secure for each human being the economic necessities, a decent standard of health and living
conditions, equal opportunities with his fellow citizens, and the highest possible degree of self
respect and freedom of thought and action without interfering with same rights of others.

General welfare and Economic welfare:

General welfare of an individual refers to the state of mind or happiness which an

individual enjoys due to number of factors such as economic and also various other factors
such as friendship, health, religious beliefs, philosophical outlook on life and so on. Thus,
general welfare refers to the satisfaction derived by an individual from both economic and non-
economic factors.

Economic welfare is a function of the satisfaction derived from the use of exchangeable
material goods and services almost confine with real national income of the community.
Economics confines itself to social welfare of all persons alone. The subject of economics is
the well-being of persons as consumers and producers and the possible ways of improving that
well-being or welfare.

Welfare Economics:

Economics can be divide as ‘Positive economics’ And ‘Welfare economics ‘. Positive

economics may be said refer to the analysis of the theories or principles of economics, while
welfare economics may be said to confine itself to an examination of economic policies.
Positive economics builds up analytical tools; welfare economics applies such tools to specific
economic situations to maximize economic welfare. Positive economics is merely theoretical;
welfare economics is prescriptive in nature.

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 Social welfare maximization

Social welfare

Social welfare is an aggregate of the utilities or satisfaction of all the individuals

in the society. In short, it is a collective utility for a group of people. The group of people may
be like family, friend group, civic organization, town, state and country.

The welfare of all the individuals is synonymous with the welfare of the society. The
object of social welfare is to secure for each human being the economic necessities, a decent
standard of health and living conditions, equal opportunities with his fellow citizens, and the
highest possible degree of self respect and freedom of thought and action without interfering
with same rights of others.

Ways to construct social welfare

1. Value
2. Add everyone utility
3. Stakeholder

Social welfare function

A social welfare function is a function that ranks different social state as more or
less desirable or even indifferent for every pair of social state.

Concepts of social welfare function

1. The classical social welfare function

2. Pareto social welfare function
3. Bergson’s Samuelson social welfare function
4. Compensation criteria
a. The kaldor’s criterion
b. The Hicks criterion
c. The Scitovsky double criterion

1. The classical social welfare function

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 Social welfare function is put forward by classical economist like Bentham,
Pigou and Marshall. According to them “social welfare is the sum of cardinal utility obtain by
all members (individual) in the society”

Cardinal Utility is the idea that economic welfare can be directly observable
and be given a value. For example, people may be able to express the utility that consumption
gives for certain goods. For example, if a Nissan car gives 5,000 units of utility, a BMW car
would give 8,000 units.

Mathematically:

W=U1+U2+.....................+Un

W denotes social welfare

U1+U2+U3 etc represent the cardinal utilities of the individual members of

the society

The aim of the society is maximise social welfare i.e the aggregate of utility of
the individual in the society.

Assumption of The classical social function

1. Law diminishing utility applies to money and income .hence, maximum social welfare
can achieve if income so distributed then the marginal utility will be equal for all
individual in the society
2. Various individuals have same taste and same capacity of satisfactions. With the Result,
the utility functions are alike (same).

Thus, according to the classical welfare function, the maximisation social welfare
is achieved by equal distribution of income.

2. Pareto social welfare function

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 Pareto was the first economist to find out an objective test of social welfare
maximum. Often called Pareto optimality, Pareto unanimity rule, Paretian optimum, social or
general optimum, the Paretian criterion states that “welfare is said to increase (or decrease) if
at least one person is made better off (or worse off) with no change in the positions of others.”

In other words, any change which harms no one and which makes some people better
off (in their own estimation) must be considered to be an improvement. Given certain rules of
distribution, any economic reorganization is said to increase social welfare, if the welfare of
some persons is increased without any decrease in the welfare of others

Let us explain Pareto’s criterion with the help of utility possibility curve, as in Fig. 1

Suppose there are two individuals A and В sharing a given bundle of good X. A’s utility
is represented on the horizontal axis and B’s utility on the vertical axis. Thus BA represents
utility possibility curve of all combinations of the individual utilities. The Paretian criterion
shows that any change which causes a movement from С to F on the production possibility
curve BA is an improvement because it makes both individuals better off thereby maximising
their welfare. Similarly, a movement from С to D or E on the BA curve is an improvement for
it makes at least one person better off without making the other worse off. But any point outside
the segment DE is not a Pareto improvement. For instance, any movement from С to H
increases B’s welfare at the expense of A’s welfare.

3. Bergson Criterion Social welfare maximization

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 In welfare economics, a social welfare function is a function that ranks social states
(alternative complete descriptions of the society) as less desirable, more desirable, or
indifferent for every possible pairof social states. One use of a social welfare function is to
represent prospective patterns of collective choice as to alternative social states. The social
welfare function provides the government with a simple guideline for achieving the optimal
distribution of income.

The social welfare function is analogous to the consumer theory of indifference-curve–budget

constraint tangency for an individual, except that the social welfare function is a mapping of
individual preferences or judgments of everyone in the society as to collective choices, which
apply to all, whatever individual preferences are for (variable) constraints on factors of
production. One point of a social welfare function is to determine how close the analogy is to
an ordinal utility function for an individual with at least minimal restrictions suggested by
welfare economics, including constraints onthe number of factors of production

Bergson Criterion

According to the Bergson in a ordinal index of social welfare “social welfare is the
function of utility level of all individual in the society.

Thus, Social welfare represented as W=f (U1, U2 U3 U4....... Un)

U1, U2 U3 U4 etc are utility index of individuals. Like indifference curves welfare
functions can also have lower or higher levels.

The various welfare criteria so far discussed show that when a change in the
economy benefits some individuals and hurts others it is impossible to evaluate it without
making some value judgement about the deservingness of the different individual or
groups. Bergson suggested the use of an explicit set of value judgements in the form of a
social welfare function. A social welfare function is analogous to the individual
consumer's utility function. It provides a ranking of alternative states (situations,
configurations) in which different individuals enjoy different utility levels.

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If the economy consists of two individuals the social welfare function could bepresented
by a set of social indifference contours (in utility space) like the Ones shown in figure.
Each curve is the locus of combinations of utilities of A and B which yield the same level
of social welfare. The further to the righta social indifference contour is, the higher the
level of social welfare will be.With such a set of social indifference contours alternative
states in the economy can be unambiguously evaluated. For example a change which
would move the society from point b to point c (or d) increases the social welfare. A
change moving the society from a to b leaves the level of social welfare unaltered. The
problem with the social welfare function is that there is no easy method of constructing
it. Its existence is axiomatically assumed in welfare economics. Somebody in the
economy must undertake the task of comparing the various individuals or groups and rank
them according to what he thinks their worthiness is. A democratically elected
government could be assumed to make such value judgements which would be acceptable
by the society as a whole. This is implicitly or explicitlyassumed when use is made of the
apparatus of the social welfare function. It should be noted that the social welfare function
cannot be used to derive social (or community) indifference curves in output space
(analogous to theindifference curves of a single individual) without taking into account
the distribution of income among the various individuals in the economy.

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DETERMINATION OF THE WELFARE-MAXIMISINGSTATE: THE 'POINT
OF BLISS'.

In figure the grand utility possibility frontier is combined with the Social welfare function
shown by the set of social indifference contours. Social welfare is maximised at the point of
tangency of the'envelope' utility possibility frontier with theA highest possible social indifference
B.
contour. This point is called 'the point of bliss'. It is denoted by w• in figure. The maximum
social welfare attainable in our example is the level implied by the indifference contour W3 .
The two consumers will enjoy the levels of utility U• and U•

We can now see why the Pareto-optimality is a necessary but not sufficient condition for
welfare maximisation. The welfare maximisation will occur at a point on the 'envelope'
utility possibility frontier, and we saw that all points on this frontier satisfy all three
conditions of Pareto optimality. Thus, the point of welfare maximisation is a Pareto-optimal
state. However, a large number of points below the grand utility frontier, although not
Pareto-optimal, yield a higher level of social welfare than points on the utility frontier. For
example, point N in figure is a Pareto-optimal situation while pointL is not. Yet L lies on a
higher social indifference contour than point N. However, it can be shown that, given any
inefficient point (below the 'envelope' utility frontier), there will exist some point(s) on the
grand utility frontier that represents an improvement in social welfare.

4.Compensation criteria

d. The kaldor’s criterion

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 e. The Hicks criterion
f. The Scitovsky double criterion

a. The kaldor’s criterion

Allocation A is socially preferable to B if those who gain from A could

compensate the loser

B. The Hicks criterion

Allocation A is socially preferable to B if those who would lose from A could not
profitable bribe the gainers into not making the change from B to A

c. The Scitovsky double criterion

Allocation of A is socially preferable if the gainers could bribe the gainers into
accepting the change and simultaneously the losers could not bribe the gainers into not
making the change.