General Equilibrium Model

L-1/1
 Contents
• Partial vrs. General equilibrium
• Walrasian S
• System GE
• Paretian system of General Equilibrium
 Walrasin General Equilibrium Model
1. It defined as state in which all the markets and
decisions making units are in simultaneous
equations.
• If each market is cleared at a positive price.
• Consumer maximising satisfaction.
• Firm maximising profits.
• Product market and factor market must be
determined simultaneously.
2. GEM simultaneous equation model
• Millions of unknown with millions of equations.
• Behavioural equations: dd and ss functions
• Clearing market mechanism.
 GEM: Léon Walras, 
• Léon Walras (French: 16 December 1834 – 5 January 1910) was a French 
mathematical economist and Georgist.
•  He formulated the marginal theory of value (independently of 
William Stanley Jevons and Carl Menger) and pioneered the development
of general equilibrium theory.
• Contributions Walras's law , General equilibrium.
• In 1874 and 1877 Walras published Éléments d'économie politique
pure (1899, 4th ed.; 1926, éd. définitive),
• Inn English, Elements of Pure Economics (1954), translated by William Jaffé.
• That work that led him to be considered the father of the 
general equilibrium theory.
•  Walras's law implies that the sum of the values of excess demands across
all markets must equal zero, whether or not the economy is in a general
equilibrium.
• This implies that if positive excess demand exists in one market, negative
excess demand must exist in some other market. Thus, if all markets but
one are in equilibrium, then that last market must also be in equilibrium.
 GEN: Leon Walras
1.All the prices and quantities in all markets determined
simultaneously.
2.It is presented by a set equations.
3.Consumers have double role: he buys commodities and sells factors
of productions to firms.
• Dd for commodities means quantities of commodities it produces.
• Ss of factor inputs means dd for factor inputs.
• Simultaneity means inter dependency.
• Millions of SEM with unknowns.
4. Three characteristics.
• Many markets=Many commodities=many factors of productions.
• Ss function=dd functions=clearing the market.
• Commodity market=dd functions= no. Of conumers.
• SS function=no of firms.
• No of equation= no.unknowns.
Economic efficiency: Pareto Optimality
• Velfredo Pareto (1848-1923): rejected the classical
view of social welfare
1. Cardinal utility and additive nature
2. Interpersonal comparison of utility
• Pareto Criterion
1. Improvement
2. Optimality/efficiency
• Pareto improvement is a position from which it is possible to make
someone better off without making someone worse off by any re-
allocation of resources and outputs.
• Pareto optimality is a position from which it is impossible to make
anyone better off without making someone worse off by any re-
allocation of resources and outputs.
• Government policy change applies in case of PO.
 Assumption of Pareto Optimality
• Each individual has his own ordinal utility function
and poses a definite amount of each product and
factor.
• Production function of every firm and state of
technology is given and remains constant
• Goods are perfectly divisible.
• A producer tries to produce a given output with the
least cost combination of factors
• Each individual wants to maximize his satisfaction.
• Every individual purchase some quantity of all goods.
• All factors of production are perfectly mobile.
 Pareto Efficiency Conditions
• Exchange Efficiency
• Production Efficiency
• Product Mix Efficiency
 Exchange Efficiency
• Exchange efficiency means the distribution of
a given output of goods between individuals in
a society should be such that it should not be
possible to make someone better off without
making anyone else worse off.
• The marginal condition for a Pareto Optimal or
Efficient distribution of commodities among
consumers requires that the MRS between
two goods must be same for every individual
who consumes them both.
• MRS xy of A = MRS xy of B
 Explanation of the diagram
• Draw a Contract curve
• MRS between the two goods for individuals A
and B are equal on the various points of the
Contract curve CC’.
• Any point outside the CC does not represent
the equality of MRS.
• At point K, MRS xy of A is not equal to MRS xy
of B.
• So movement from K to QS segment of any
point on CC’ increase the social welfare.
 Production Efficiency
• Pareto efficiency in production is possible by
reallocating the resources is such a way that resources
to produce more of some goods without producing
less of some other goods.
• Use of Resources by a firm for production of a good or
goods is efficient when it produces any given output at
the minimum possible cost or a given cost outlays.
• The marginal condition for a Pareto optimal allocation
of factors (inputs) requires that the MRTS between
any pair of factors must be equal the same for any two
firms producing any two products and using both the
factors to produce the products.
• MRTS lk of A = MRS lk of B
 Explanation of the diagram
• Draw a Contract curve
• MRTS for ne factors for another is the amount of one
factors necessary to compensate the loss of the
marginal unit of the anther so that the level of output
remains the same.
• MRTS between the two goods for firm A and B are
equal on the various points of the Contract curve CC’.
• Any point outside the CC does not represent the
equality of MRTS.
• At point K, MRTS xy of A is not equal to MRTS xy of B.
• So movement from K to QS segment of any point on
CC’ increase the social welfare.
 Product Mix efficiency
• The product mix efficiency means that allocation of
resources among the production of various goods and
services is in accordance with the preferences of the people.
• The marginal conditions for a Pareto Optimal or efficient
composition of output requires that the MRPT (Marginal
Rate of product transformation) between any two
commodities be equal to the MRS between the same two
goods.
• MRPTxy = MRSxy of A = MRSxy of B
• MRPT says the rate at which a good can be transformed into
another.
• MRS xy = rate at which consumer are willing to exchange a
good for another.
 Explanation of the diagram
• AB is a community transformation curve. It
represents an amount of X can be produced
for any amount of Y with a fixed supply of
available resources.
• MRSxy of A = MRSxy of B= MRPT at point R.
• R represents optimum combination of
production in which commodities X and Y are
being produced and consumed in OM and ON
quantities.
• At point S, consumer is at lower IC.
 Product Mix with Edgeworth Box
• TT’ is society product transformation curve.
• At L, ox1 of X and oy1 of Y is produced.
• Thus production at L and consumption at S
can not be Pareto Optimum.
• In diagram 2, at point Q of TT’, greater of Y
and smaller of X is produced.
 Critical evaluation of PC and PO
1. It is not completely free from value judgment.
2. PC can not be applied to judge the social desirability of
those policies proposals which benefit some and harm
others. Whenever, there is conflict of preferences of two
individuals with respect to two alternatives, the criteria
fails to rank those two alternatives no matter what the
preferences of the rest of the individuals in the society
might be. P.K. Paitnaik.
3. PC leaves a considerable amount of indeterminacy in the
welfare analysis since every point in CC is pareto optimal.
4. PC accepts the prevailing income distribution and no
attempt is made to find out an optimum distribution of
income.
 A.K. Sen Critique of PO
1. A State can be PO with some people in extreme misery and others
rolling in luxury, so long as the miserable cannot be made better off
without cutting into the luxury of the rich. A.K. Sen
2. He criticized the utility based PO. Utility is interpreted in
happiness and desire-fulfillment. Utility does not always reflect
well being.
3. Well being is ultimately a matter of valuation and while happiness
and fulfillment of desire may well be valuable for the person’s well
being, they cannot-on their own way or even together- adequately
reflect the value of well being.
4. Welfare or well being is also affected by political and
environmental factors.
5. A reorganization that gives everyone more income and leisure
might not improve the welfare of the community if at the same
time it limits individual freedom or requires the abandonment of
cherished culture and traditions.
Economic efficiency: Pareto Optimality
• Velfredo Pareto (1848-1923): rejected the classical
view of social welfare
1. Cardinal utility and additive nature
2. Interpersonal comparison of utility
• Pareto Criterion
1. Improvement
2. Optimality/efficiency
• Pareto improvement is a position from which it is possible to make
someone better off without making someone worse off by any re-
allocation of resources and outputs.
• Pareto optimality is a position from which it is impossible to make
anyone better off without making someone worse off by any re-
allocation of resources and outputs.
• Government policy change applies in case of PO.
 Assumption of Pareto Optimality
• Each individual has his own ordinal utility function
and poses a definite amount of each product and
factor.
• Production function of every firm and state of
technology is given and remains constant
• Goods are perfectly divisible.
• A producer tries to produce a given output with the
least cost combination of factors
• Each individual wants to maximize his satisfaction.
• Every individual purchase some quantity of all goods.
• All factors of production are perfectly mobile.
 Pareto Efficiency Conditions
• Exchange Efficiency
• Production Efficiency
• Product Mix Efficiency
 Exchange Efficiency
• Exchange efficiency means the distribution of
a given output of goods between individuals in
a society should be such that it should not be
possible to make someone better off without
making anyone else worse off.
• The marginal condition for a Pareto Optimal or
Efficient distribution of commodities among
consumers requires that the MRS between
two goods must be same for every individual
who consumes them both.
• MRS xy of A = MRS xy of B
 Explanation of the diagram
• Draw a Contract curve
• MRS between the two goods for individuals A
and B are equal on the various points of the
Contract curve CC’.
• Any point outside the CC does not represent
the equality of MRS.
• At point K, MRS xy of A is not equal to MRS xy
of B.
• So movement from K to QS segment of any
point on CC’ increase the social welfare.
 Production Efficiency
• Pareto efficiency in production is possible by
reallocating the resources is such a way that resources
to produce more of some goods without producing
less of some other goods.
• Use of Resources by a firm for production of a good or
goods is efficient when it produces any given output at
the minimum possible cost or a given cost outlays.
• The marginal condition for a Pareto optimal allocation
of factors (inputs) requires that the MRTS between
any pair of factors must be equal the same for any two
firms producing any two products and using both the
factors to produce the products.
• MRTS lk of A = MRS lk of B
 Explanation of the diagram
• Draw a Contract curve
• MRTS for ne factors for another is the amount of one
factors necessary to compensate the loss of the
marginal unit of the anther so that the level of output
remains the same.
• MRTS between the two goods for firm A and B are
equal on the various points of the Contract curve CC’.
• Any point outside the CC does not represent the
equality of MRTS.
• At point K, MRTS xy of A is not equal to MRTS xy of B.
• So movement from K to QS segment of any point on
CC’ increase the social welfare.
 Product Mix efficiency
• The product mix efficiency means that allocation of
resources among the production of various goods and
services is in accordance with the preferences of the people.
• The marginal conditions for a Pareto Optimal or efficient
composition of output requires that the MRPT (Marginal
Rate of product transformation) between any two
commodities be equal to the MRS between the same two
goods.
• MRPTxy = MRSxy of A = MRSxy of B
• MRPT says the rate at which a good can be transformed into
another.
• MRS xy = rate at which consumer are willing to exchange a
good for another.
 Explanation of the diagram
• AB is a community transformation curve. It
represents an amount of X can be produced
for any amount of Y with a fixed supply of
available resources.
• MRSxy of A = MRSxy of B= MRPT at point R.
• R represents optimum combination of
production in which commodities X and Y are
being produced and consumed in OM and ON
quantities.
• At point S, consumer is at lower IC.
 Product Mix with Edgeworth Box
• TT’ is society product transformation curve.
• At L, ox1 of X and oy1 of Y is produced.
• Thus production at L and consumption at S
can not be Pareto Optimum.
• In diagram 2, at point Q of TT’, greater of Y
and smaller of X is produced.
 Critical evaluation of PC and PO
1. It is not completely free from value judgment.
2. PC can not be applied to judge the social desirability of
those policies proposals which benefit some and harm
others. Whenever, there is conflict of preferences of two
individuals with respect to two alternatives, the criteria
fails to rank those two alternatives no matter what the
preferences of the rest of the individuals in the society
might be. P.K. Paitnaik.
3. PC leaves a considerable amount of indeterminacy in the
welfare analysis since every point in CC is pareto optimal.
4. PC accepts the prevailing income distribution and no
attempt is made to find out an optimum distribution of
income.
 A.K. Sen Critique of PO
1. A State can be PO with some people in extreme misery and others
rolling in luxury, so long as the miserable cannot be made better off
without cutting into the luxury of the rich. A.K. Sen
2. He criticized the utility based PO. Utility is interpreted in
happiness and desire-fulfillment. Utility does not always reflect
well being.
3. Well being is ultimately a matter of valuation and while happiness
and fulfillment of desire may well be valuable for the person’s well
being, they cannot-on their own way or even together- adequately
reflect the value of well being.
4. Welfare or well being is also affected by political and
environmental factors.
5. A reorganization that gives everyone more income and leisure
might not improve the welfare of the community if at the same
time it limits individual freedom or requires the abandonment of
cherished culture and traditions.
 First Theorem of Welfare Economics
• Pareto optimality and allocation of resources
• One can make better off without making any
one else worse off, an inefficient point.
• From in-efficienct point through improvement
process, one can make Pareto efficient.
• First fundamental theorem of welfare
economics
1. Maximization of social welfare or economic
efficiency in general equilibrium frame.
2. It reflect general competitive equilibrium is
Pareto optimal
 First Theorem
• PC and Optimal Distribution of Goods or
Exchange Efficiency
1.MRS xy of A = Px/Py
2.MRS xy of B =Px/Py
3. MRS xy of A = MRS xy of B
• PC and Optimal Distribution of Factors or
Production Efficiency
1. MRTS lk of X =w/r
2. MRTS lk of Y = w/r
• MRTS lk of X =MRTS lk of Y
 PC and Optimum Directions of Production
• General economic Efficiency
• This condition states that MRS between any
two commodities for any consumer should
be same as the MR of transformation (MRT)
for the community between these two
commodities.
• MC x/ MC y = Px/ Py
• MRT xy = MC x/ MC y = Px/ Py
• MRS xy = Px/Py
• Mrs xy =MRT xy
 Criticism
• This is also called invisible hand theorem.
• General competitive equilibrium exists.
• Second order condition for equilibrium must
fulfill.
• Externality in consumption and production do
not exist.
• Pareto optimality and social justice
 Theory of Consumer Surplus
• First formulated by Dupuit in 1884 to social benefits of public
goods.
• It is further refined by and popularized by “Principles of
Economics” in 1890.
• It is basis for welfare economics.
• Marshall’s concept of CS is cardinal and interpersonal
comparison of Utility.
• CS is simple difference between the price that one is willing to
pay minus one actually pay for it for particular product.
• Greater the amount of money he is willing to pay, the greater
the utility he obtained from it.
• CS = ∑ MU – P X No. of unit of Commodity.
 Marshall’s CS
• Example: Consumption of Water.
• Two aspects are important to measure.
1. Total utility in terms of money
2. Total market value
Assumptions:
3. Cardinal Measurement of Utility.
4. Marginal Utility of Money remain constant.
5. Different units of goods give different amount of
satisfaction to the consumer.
 Example of CS
No of Units Marginal Value Price Total CS Net Marginal
(in Rs) Benefits
1 20 12 8

2 18 12 6

3 16 12 4

4 14 12 2

5 12 12 0

6 10 12 -2

Total CS 20
• CS under various situation (Marshallian Form
of CS)
1. CS Under DD Curve
2. CS and Changes in price

CS through Indifference curve

• Hicks and Allen is a ordinal concept.
• MU of money does not remain constant with
the rise and fall in real income.
 Hicksian Four Concept of CS
1. Price Compensating Variation
2. Price Equivalent Variation
3. Quantity Compensating Variation
4. Quantity Equivalent Variation

1. Price Compensating Variation

• PCV is defined by Hicks “Maximum amount of
money the consumer will be willing pay for the
privilege of buying a commodity at a lower price so
that he obtains the initial level of welfare. That is the
level of welfare he obtained before the fall in price.
2. Price Equivalent Variation
• PEV is defined by Hicks as the minimum sum of
money, the consumer will accept to receive for
forgoing the opportunity of buying at a lower price,
so that he obtains the subsequent level of welfare,
which he reaches with lower price.
3. Quantity Equivalent Variation
• QCV is defined by Hicks “As the maximum amount of
money, a consumer will be willing to pay for the
priviledge of buying a good at a lower price, if along
with this privilege he is constrained to buy the
quantity of the good, which he would buy at a lower
price, in the absence of any compensating payment”.
4. Quantity Equivalent Variation
• QEV is defined by Hicks as “the minimum sum of
money that the consumer will accept for forgoing
the opportunity of buying the commodity at the
lower price, provided he is constrained to buy the
quantity of X, which he actually buys at the old
higher price”.
• If he is constrained to buy OA amount of X, he will
accept QT amount of money for giving up the
opportunity of buying the commodity at the lower
price. This is because combination T gives same
satisfaction as combination R at which point the
consumer reaches with lower price of X.
 Criticism of CS
1. CS is quite hypothetical, imaginary and illustrative.
• Sum total of money actually spent by him on the goods cannot be
greater than his total money income.
2. It is based on invalid assumptions that different units of the goods give
different amount of satisfaction to the consumer.
3. It ignores the interdependence between the goods that is the relations
of substitute and complementary goods.
4. CS is hypothetical and imaginary:
• Prof. Nickolson says that it is difficult to say how much price a
consumer would be willing to pay for a good rather than go without it.
• J.R. Hicks says the best way to look at the CS is to regard it as a means
of expressing it in terms of money income gain which accrues to the
consumers as a result of fall in price.

5. It is based on questionable assumption of cardinal measurability of

utility and constancy of the marginal utility of money.
 Conclusion
• Formulation of economic theory and policy
• Utility is more than price paid – Adam Smith, Value in
Use and Value in Exchange
• Example: salt, match box, news paper etc.
• Amenities and Recreational Facilities:
• Prof. Samuelson says “How lucky the citizen of modern
efficient communities really are?”
• Marshallian CS was meant for formulating suitable fiscal
policy, which maximizes the welfare of the people.
• Indirect Tax and Subsidies:
• CS and CBA:
 Application of CS
• Three Major Areas
1. The Water –Diamond Paradox of Value Theory
2. The effects of taxes and subsidies on Peoples’ welfare
3. CBA of public projects
• The Water –Diamond Paradox of Value Theory
• Use value vrs market value
• Marginal valuation of a commodity reflects how much amount
of money consumer is prepared to pay for a commodity.
• Market price of a commodity is determined not by its total use
value but by its marginal valuation of marginal benefit which
is turns depends upon the actually availability of quantity.
• Total valuation or satisfaction derived from water consumed is
much greater compared with diamond but its marginal
valuation is low due to its abundant supply.
 The effects of taxes and subsidies
• Indirect tax and constant cost Industry
• Demand and SS of car
• Explain the loss of welfare due to tax
• Two components
1. Revenue collect by the govt.
2. Loss of welfare or excess of burden of sales taxation or dead
weight loss
• Gain from subsidy
• Give the example of foodgrains
• Two components
1. Total expenditure burn by govt.
2. Net gain in welfare
 CBA of Public Projects
• CBA means not only analysis of costs and benefits but also
real costs and benefits in terms of satisfaction and resources.
• It also looks social point of view
• Give one example of fly over
• No. of journey per month and cost per journey
• Two components
1. Cost saving component
2. increase in consumer surplus
Arrow theory of Social Choice

L-1
 K.J Arrow as a Economist
• Kenneth Joseph "Ken" Arrow (August 23, 1921 – February 21,
2017) was an American economist, writer, and political
theorist.
• He was the joint winner of the Nobel Memorial Prize
in Economics with John Hicks in 1972. To date, he is the
youngest person to have received this award, at 51.
•  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 
the economics of information.
 Arrow’s Social Choice
• Social Choice and Individual Values
• Arrow’s main contention that “It is difficulty to
set up reasonable democratic procedures for
the aggregation of individual preferences into
a social preferences for making a social
choice”.
• BS SWF – f (goods and services consumed him
not by others)
• SWF based on all individuals preference is
impossible.
 Arrow SWF

• Arrow has pointed out that individuals ordering of

social states does not depend exclusively upon the
commodities consumed but also on the amount of
various types of collectives such as municipal services,
parks, sanitation, erection of statues of famous men.
• Welfare results of collective activity can not be
evaluated by an individual solely on the basis of his
consumption.
• Individual ordering of social states will depend on his
own consumption as well as on the consumption of
others in the society.
 Arrow conditions of Social Choice
• Value Judgments of a super man or dictator about social
welfare may not be valid due to various types of biases in
human mind.
• Arrow was the first welfare economist, who attempted to lay
down reasonable necessary condition for achieving the social
ordering.
• Dictator can make a choice through custom and tradition,
spiritual on religious head in traditional society or by
individuals comprising a society through voting.
• Dictatonial rule on religious and traditional society, social
choice is comparutivelu each.
• Social choice in a democratic society based on individual
ordering is diffcuilti.
 Conditions
• Transitivity or Consistency – alternatives must be related
Consistency – if any pair of alternatives A and B, either A is
Preferred to B, B is preferred to A, on Indifferent between A.
• Responsiveness to Individual Preference
• Social Ranking must respond positively to the individual ranking.
• Social choice changes in the same direction of individual
preference.

• The condition of Non- imposition

• Social choices must not be imposed independently on individual
preference
• No body prefers B to A,
• An Some body A to B
• Society prefers B to A
 Conditions…..
• Condition of Non Dictatorship.
• Social Choice must not be dictated by any one
individual in the community
• Independence of Irrelevant Alternatives.
• Social ranking of any two alternatives is
determined exclusively by individual ranking
of these two alternatives above
 Impossibility Theorem

X Y Z
• A 3 2 1 (least Preference)
• B 1 3 2 (next Preference)
C 2 1 3 (Most Preference)
 
 Sen Criticism on Arrow’s theorem:

• A limited class of Information

• The poorest has no cake left to he taken away.
• If we execute the possibility of interpersonal comparisons
of Utility only method of passing from individual tastes to
social preference, which shall be satisfactory and which
will be defined for a wide range of sets individual ordering
are either. It is not possible to pass from the imposed
indication.
• Individual preferences to the social preference, so as to
construct a social welfare function.
• Free voting in a democratic process.
• Social choice would be made by majority rule.
• Social choices can not violate transitivity on consistency.
Social Welfare Functions
B-S Theory
L-I
Sanatan Nayak
 Classical view
• Sum of cardinal utilities
• Law of diminishing marginal utilities
• Equal distribution of income or Marginal
Utility of Money is constant
• Interpersonal comparison of utilities
• Critiques
• Cardinal measurement of utilities
• Sum of cardinal utilities: This is unethical or
equal weight to each person is not correct.
 SWF
• Classical SWF: Bentham, Pigou and Marshall:
Cardinal Utility
• Maximisation of social welfare is possible for
equal distribution of income
• Pareto SWF: Marginal conditions
• Rawlsian SWF: John Rowl
• Welfare criteria can be chosen, departure from
perfect equality
• Unequal distribution of utilities.
• The worst of individual is actually better off
than under equality.
 SWF-SB
• A. Bergson (1938): A reformulation of certain
aspects of Welfare Economics
• BS provided a new approach to SW
• Ordinal preferences of individuals
• Welfare Approach is individualistic
• Interpersonal comparison of utility and value
judgment
• Welfare economics can not be separated from
value judgement
 B-S SWF
• It is an ordinal index of utility
• Welfare function: W=w(U1, U2, ………Un)
• Ordinal utility index depends on goods and services
consumed.
• Three proposition:
• B-S SWE depends solely on the utility of individual welfare
in the society.
• Value Judgment can be obtained through democratic
process through voting by individual.
• Agents of value of Judgment- economists need not himself
decide about, the desirable distribution of welfare.
• Ordinal Utility is function of own condition of goods &
services.
 B-S SWF cont ….
• SWF function is attained by common consensus
or it may be forced upon the society by a
dictator.
• Problem of choosing an agent by authority “who
can give biased value judgment superman”.
• Democratic government on process of
democratization of mixing welfare.
• Rule of transitivity
 Representation of BS
• SWF : A social IC is a locus of various
combination of utilities of A & B, which results
an equal level of social welfare.
• The consideration of fairness and equality are
incorporated into the welfare function and
are reflected in the sphere of social IC.
• BS SWF arrives a solution for maximum social
welfare which combines efficiency and equity.
• Point of Contrained Bliss: Equity and efficiency.
 Summary of B-S
• Value Judgement and Inter personal
comparison of utility.
• Distribution of welfare is possible through value
judgement.
• There is no unique value judgement process but
set of value judgement can construct a SWF.
• SWF provides unique optimum solution with
efficiency and equity, i.e., Constrained Bliss.
 Critical evaluation of BS
• Little, Streeten and Baumol have pointed SWF have
limited practical use.
• Little- SWF can neither be used in democratic state non
in totalitarian state.
• Baumol: SWF is have limited practical value, as it does
not tell us how to get the value judgements, which it
requires for its construction.
• J.K.Mehta:- SWF is possible, when superman or
authority initiate representative state, or unbiased or
selfless.
• It might improve the welfare of the community it at the
same time it limits individual freedom or requires the
abandonment of cherished cultural traditions.
 Reference
• A. Bergson (1938), “A Reformulation of Certain
aspects of Welfare Economics”, The Quarterly
Journal of Economics, Vol. 52, No. 2., pp. 310-
334.
 Compensation Principles
• Due to economic re-organisation, which makes some
people better off and others worse off.
• Assumption
1. The satisfaction of an individual is independent of
the others
2. There is no externality of consumption and
production
3. The test of consumer remains constant.
4. The problems of production and consumption can
be separated from distribution.
5. Utility can be measured ordinally and interpersonal
comparison of utility is not possible.
 H-K welfare criterion: Compensation principles
• K-H Compensation Criteria says:
• If certain change occur due to economic reorganization policy change.
Some people better off and others worse off. Then that change will
increase social welfare if those who gain from the changes could
compensate the losers and still be better off than before.
• J.R. Hicks Supported the view of compensation Criteria:-This case is
improvement then the re-organisation.
• DE is the utility possibility curve.
• When we more down ward, utility of A Up es and b Down es.
• The movement from Q to T, B better off and A worse of .
• Utility.
• R is the point, where both A remain same and B better off.
• Movement from Q to R,
• Q to S, Would increases both.
• Due to economic change any movement for lower UPC to higher UPC,
would make better off the position.
 H-K welfare criterion cont …….
• H.K.Criteria says compensation may not be
actually paid to judge whether or not social
welfare has increased. It is enough to know
whether the gainer could compensate the
loser for the loss in his welfare and still be
better off.
• It says change in output and change in
distribution.
 UPC move outwards
• What happens to social welfare due to economic policy and
UPC moves outward.
• Any change in the economy that moves the individual from a
position on a lower utility possibility curve to a position on a
higher utility possibility curve increases social welfare.
 Scitovsky Paradox
• Important limitation to H-K principles.
• If B is an improvement to A by H-K principles, then it is
possible, A can be improvement over B on the same
criteria.
• H-K involve contradictory and inconsistency situation.
• JK and GH are two UPC.
• C is the original position. Due to policy change, higher
UPC and point is at D.
• Movement from C to D, satisfy the H-K criteria.
• According to Scitovsky, reverse movement from D to C,
social welfare also increases.
 Scitovsky double criterion
• Full fills the requirement of H-K hypothesis & fulfillment of
the reversal case.
• Change is an improvement if gainers in the changed situation
are able to persuade the losers to accept the change and
simultaneously losers are not able to persuade the gainers to
remain in the original situation.
• CD and EF are two UPC parallel. Movement from Q to R
increase social welfare. Thus H-K satisfy.
• Movement from G to Q does passed by the H-K criteria.
• Thus when two UPC not intersecting and change involves
movement from a position on a lower UPC to a position on a
higher UPC, the changes rises social welafre on basis of H-K -
S criteria.
 Criticism of H-K Criteria
• H-K Principle does not require actual compensation to
be paid but it is not necessary that the benefits can
compensate the losers.
• Little H-K focus on efficiency not distribution.

• (Prof. Baumol & Little) Compensation criteria is not free

from value Judgment that situation it self is a value
judgment.
•
• It is not free from interpersonal comparison of utility.
• Potential welfare rather than actual welfare
Samuelson’s view.
Theory of Capability
Nassubum and
A.K. Sen

Dr Sanatan Nayak
Brief History of Martha Nussbaum
• Martha Craven Nussbaum was born on May 6, 1947 is an
American philosopher.
• Nussbaum is the author or editor of a number of books,
including The Fragility of Goodness (1986), Sex and Social
Justice (1998),The Sleep of Reason (2002), Hiding From
Humanity: Disgust, Shame, and the Law (2004), and Frontiers of
Justice: Disability, Nationality, Species Membership (2006).
• She taught philosophy and classics at Harvard in the 1970s and
early 1980s, where she was denied tenure by the Classics
Department in 1982.[3] Nussbaum then moved to 
Brown University, where she taught until 1994 when she joined
the University of Chicago Law School faculty. Her 1986 book The
Fragility of Goodness, on ancient Greek ethics and Greek tragedy,
made her a well-known figure throughout the humanities. More
recent work (Frontiers of Justice) establishes Nussbaum as a
theorist of global justice.
 Structure and Development of Martha
Nussbaum’s Capability Theory
• Nussbaum 'Central Capabilities:
• Life: Being able to live to the end of a human life of normal length; not
dying prematurely, or before one’s life is so reduced as to be not worth
living.

• Bodily health : Being able to have good health, including reproductive

health; to be adequately nourished; to have adequate shelter.

• Bodily Integrity: Being able to move freely from place to place; to be secure
against violent assault, including sexual assault and domestic violence;
having opportunities for sexual satisfaction and for choice in matters of
reproduction.

• Senses, imagination and thought: Being able to use the senses, to imagine,
think, and reason – and to do these things in a ‘‘truly human’’ way, a way
informed and cultivated by an adequate education, including, but by no
means limited to, literacy and basic mathematical and scientific training.
 Structure and Development of Martha
Nussbaum’s Capability Theory cont ...
• Emotions: Being able to have attachments to things and people
outside ourselves; to love those who love and care for us, to
grieve at their absence; in general, to love, to grieve, to
experience longing, gratitude, and justified anger.
• Practical reason: Being able to form a conception of the good
and to engage in critical reflection about the planning of one’s
life. 
• Affiliation: Being able to live with and toward others, to
recognize and show concern for other human beings, to engage
in various forms of social interaction; to be able to imagine the
situation of another. 
• Other species: Being able to live with concern for and in relation
to animals, plants, and the world of nature.
• Play: Being able to laugh, to play, to enjoy recreational activities.
 Structure and Development of Martha
Nussbaum’s Capability Theory cont ...
• Control over one’s environment:
• Political: Being able to participate effectively in
political choices that govern one’s life; having the
right of political participation, protections of free
speech and association.
• Material: Being able to hold property (both land and
movable goods), and having property rights on an
equal basis with others; having the right to seek
employment on an equal basis with others; having
the freedom from unwarranted search and seizure.
 Brief of AK Sen
• Amartya Kumar Sen born 3 November 1933) is an Indian
 economist and philosopher of Bengali ethnicity.
• Since 1972 has taught and worked in the United Kingdom and the
United States.
• Sen has made contributions to welfare economics, 
social choice theory, economic and social justice, economic theories
of famines, and indexes of the measure of well-being of citizens of
developing countries.
•  He was awarded the Nobel Memorial Prize in Economic Sciences
 in 1998 and Bharat Ratna in 1999 for his work in welfare
economics, Charleston-EFG John Maynard Keynes Prize in in
February 2015 by the Royal Academy in the UK.
• He is currently the Thomas W. Lamont University Professor and
Professor of Economics and Philosophy at Harvard University. He
served as the chancellor of Nalanda University. He is also Fellow
of Trinity College, Cambridge, where he served as Master from
1998 to 2004.
• Thesis, which was on "The Choice of Techniques" in 1959
 Major Achievements
• Has written many books such as Collective Choice and Social
Welfare, On Economic Inequality, Poverty and Famines: An Essay
on Entitlement and Deprivation, Choice, Welfare and
Measurement, OUP, 1982, Resources, Values and Development,
OUP, 1984, Commodities and Capabilities, OUP, 1987, India:
Economic Development and Social Opportunity (With Jean Dreze),
Development As Freedom, AUP, 2000, India: Development and
Participation (With Jean Dreze), OUP, 2002, The Argumentative
Indian, 2005, Penguin; The Idea of Justice, 2009, An Uncertain
Glory: India and Its Contradictions ((With Jean Dreze), 2013;
Development Economics, Social Choice Theory (for which Noble
prize in 1998) and Philosophy, Development as Freedom in 1999.
• Sen first introduced the concept of capability in his Tanner Lectures
on Equality of What?  in 1979) and went on to elaborate it in
subsequent publications during the 1980s and 1990s.
• This approach is connected with Aristotle, Adam Smith and Karl
Marx.
 Definition of Capability Approach
• Capability, he means, “that a person has the substantive
freedom, he or she enjoys to lead the kind of life, he or she has
reasons to value” (Sen, 2000).
• Income poverty vrs. Lack of political power to vote.
• Old age pension vrs unemployment.
• It includes various types freedoms such as political freedom,
economic facilities, social opportunities, transparency
guarantees and protective security.
• Income deprivation vrs capability deprivation.
• He proposed public interventions for reduction of inequality or
poverty (in wider sense) for establishment of capabilities of
persons based on age (old age and young), gender and social
roles (custom based family obligations), by location
(proneness to flood, drought, or insecurity or violence),
epidemiological environment (through dieses in a region).
 Capability Deprivation
• Hence, conversion of capabilities deprivation is essential in addition to
lowness of income.
1. Income and capability gets affected by persons of age, gender social
roles, locations.
2. Income deprivation and adversity in converting income into functions.
3. Distribution within family.
4. Relative deprivation in terms of income can yield absolute deprivation
in terms of capability
5. Income poverty and capability poverty.
• According to Sen, “the notion of poverty as capability of inadequacy
from that of poverty as lowness of income, these two perspectives cannot
but be related, since income is such an important means to capabilities.
And since enhanced capabilities in leading a life would tend, typically,
to expand a person’s ability to be more productive and earn a higher
income, we would also expect a connection going from capability
improvement to greater earning power and not only the other way
round”.
 Income Poverty and Capability Poverty
• Public Action in reducing inequality and poverty
• Market reforms and social facilities or opportunities
• East Asia and south east asia
• investing in education and health care to control income
deprivation at the end
• entitlements and capability improvement.
• America vrs Europe, China and Srilanka.
• Gender Inequality, sex ratio, excess mortality, litaracy rate
among females etc.
 Significant Observations
• Income Inequality and Economic Inequality.
• Valuation of Diverse capability
• Public Discussion and Social Participation
 Measurement of Human Capabilities
• Output based measures: GNP or GDP
• 1.it show country economic prosperity and
improve living standards
• Lacks to measure of well beings and quality of
life
• Women and Cultural Universals
• Faminism
• Greatest goods for all human being
• Monetray and Non-Monetary measures of
well beings
 Critique of output based capability
• Faminist critiques
• Distribution of wealth to women
• Unpaid works
• Woman's human rights
• Environmental Critiques
• Nuclear weapons
• Defence expenditure
• Deduction in accountings
• Technical and misinterpretations critiques
• Kuznet: quantity and quality of growth, costs
and returns, short term and long run
 Alternative measures
• Human Development index (HDI)
• Gender related development Index (GDI): gender
related within HDI
• Gender Empowerment Measures (GEM): woman
employment in high economic ranking jobs, seats in
parliments and share of households income.
• Gender Inequality Index (GDI): reproductive health,
empowerment and labour force participation
• Human Poverty Index (HPI): Non-income based income
(UNDP)
• Gross National Happiness (GNP): see reference
 Sustainable Livelihood: Types of Capital
• Physical Capital
• Natural capital: Renewable vrs non-renewable
capital
• Human capital
• Social capital: Knowledge assets
• Financial Capital
• These three are complementary capital
 References
• Commodities and capabilities, A.K. Sen, OUP, 1998.
• A work in Progress, the Hindu, Date:19.05.2016, p.11. develop
the work.
• Development As Freedom, AUP, 2000.