Welfare Economics

… a core concept in Economic Analysis and Atlas102

Concept description

Investopedia (reference below) defines welfare economics as a branch of economics that focuses on the optimal allocation of resources and goods and how this affects social welfare.

“Welfare economics analyzes the total good or welfare that is achieve at a current state as well as how it is distributed. This relates to the study of income distribution and how it affects the common good.
Welfare economics is a subjective study that may assign units of welfare or utility in order to create models that measure the improvements to individuals based on their personal scales.

“Welfare economics uses the perspective and techniques of microeconomics, but they can be aggregated to make macroeconomic conclusions. Because different “optimal” states may exist in an economy in terms of the allocation of resources, welfare economics seeks the state that will create the highest overall level of social welfare.”

Fundamental theorems of welfare economics

Wikipedia, reference below, describes the two fundamental theorems as follows:

The First Theorem states that a market will tend toward a competitive equilibrium that is Pareto optimal when the market maintains the following three attributes:

1. complete markets – No transaction costs and because of this each actor also has perfect information, and

2. price-taking behavior – No monopolists and easy entry and exit from a market.

3. local nonsatiation of preferences – No two market allocations give any market actor equal satisfaction.

The Second Theorem states that, out of all possible Pareto optimal outcomes, one can achieve any particular one by enacting a lump-sum wealth redistribution and then letting the market take over.

Wikipedia notes that:

“The First Theorem is often taken to be an analytical confirmation of Adam Smith’s “invisible hand” hypothesis, namely that competitive markets tend toward an efficient allocation of resources. The theorem supports a case for non-intervention in ideal conditions: let the markets do the work and the outcome will be Pareto efficient. However, Pareto efficiency is not necessarily the same thing as desirability; it merely indicates that no one can be made better off without someone being made worse off. There can be many possible Pareto efficient allocations of resources and not all of them may be equally desirable by society.

“This appears to make the case that intervention has a legitimate place in policy – redistributions can allow us to select from all efficient outcomes for one that has other desired features, such as distributional equity. The shortcoming is that for the theorem to hold, the transfers have to be lump-sum and the government needs to have perfect information on individual consumers’ tastes as well as the production possibilities of firms. An additional mathematical condition is that preferences and production technologies have to be convex.”

Sources

Investopedia, Welfare Economics, at http://www.investopedia.com/terms/w/welfare_economics.asp, accessed 18 April 2016.

Wikipedia, Welfare economics, at https://en.wikipedia.org/wiki/Welfare_economics, and Fundamental theorems of welfare economics, at https://en.wikipedia.org/wiki/Fundamental_theorems_of_welfare_economics, accessed 18 April 2016.

Atlas topic, subject, and course

The Study of Economics (core topic) in Economic Analysis and Atlas102 Economic Analysis.

Page created by: Ian Clark, last modified on 30 April 2016.

Image: Ramon Madronio, Welfare Economics, at http://www.slideshare.net/ramonnoriel/welfare-economics-14288689, accessed 18 April 2016.